Ed uc a tio n al Mat e rial s

Harold S. Novikoff, Panel Leader |

Wachtell, Lipton, Rosen & Katz; New York

American Bankruptcy Institute

NEW YORK UNIVERSITY SCHOOL OF LAW Thirty-Sixth Annual LAWRENCE P. KING AND CHARLES SELIGSON WORKSHOP ON BANKRUPTCY AND BUSINESS REORGANIZATION (September 22-23, 2010) The Dodd-Frank Wall Street Reform And Consumer Protection Act: Title II Orderly Liquidation Authority

American Bankruptcy Institute

On July 21, 2010, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203 (the Act or Dodd-Frank Act). The purpose of Title II of the Act is to provide the necessary authority to liquidate failing financial companies that pose a systemic risk to the financial markets of the United States in a manner that mitigates such risk without relying upon taxpayer expense and minimizes moral hazard. See 204(a). I. Description of Financial Companies Capable of Posing Systematic Risk A. The Orderly Liquidation provisions of the Dodd-Frank Act apply to any financial company, which is defined as a company organized under the laws of the United States that is: 1. 2. A bank holding company as defined by the Bank Holding Company Act of 1956 (12 U.S.C. 1841(a)). A nonbank financial company supervised by the Federal Reserve Board of Governors (the Board of Governors) pursuant to section 113 of the Act. Any company predominantly engaged in activities that the Board of Governors has determined are financial in nature or incidental thereto for purposes of the Bank Holding Company Act. A subsidiary of any of the above engaged in activities that the Board of Governors has determined are financial in nature or incidental thereto for purposes of the Bank Holding Company Act (other than insurance companies or federally insured depositary institutions). See 201(a)(11).

3.

4.

B.

This definition includes a broker/dealer registered with the Securities and Exchange Commission (SEC) that is also a member of the Securities Investor Protection Corporation (SIPC). The definitions in (3) and (4) above do not apply if a companys consolidated revenues from financial activities constitute less than 85% of the total consolidated revenues of such company. For the purposes of (3) and (4) above, the consolidated revenues derived from the ownership or control of a federal depositary institution are included. See 201(b). Any financial company or broker/dealer that becomes subject to Orderly Liquidation under Title II of the Act is referred to by the Act as a covered financial company or covered broker/dealer, respectively.

C.

D.

E.

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F. The Nonbank Financial Company category captures any entity predominantly engaged in financial services. see 201(a)(11)(B)(ii). 1. To fit within this category, at least 85% of a particular companys consolidated revenues or assets must stem from activities that are financial in naturea defined term under existing law that largely covers banking, lending, underwriting, insurance, investment, and other activities unrelated to general commercial services or manufacturing. The nonbank financial company category is quite large, extending possibly to thrifts and their holding companies, broker-dealers, investment advisers (potentially including managers of hedge funds and private equity funds), investment banks, and other asset management firms. Whether a company is a nonbank financial company is determined by the Financial Stability Oversight Council (the Council), a super regulator established by the Act as the nations systemic risk regulator. Assuming a company is predominantly engaged in activities that are financial in nature, the Councilby a supermajority votemay designate the company as a nonbank financial company (subjecting it to enhanced supervisory measures) based upon, among other things, the following considerations: a. b. c. the extent of the leverage of the company; the extent and nature of the off-balance-sheet exposures of the company; the extent and nature of the transactions and relationships of the company with other significant nonbank financial companies and significant bank holding companies; the importance of the company as a source of credit for households, businesses, and State and local governments and as a source of liquidity for the United States financial system; the importance of the company as a source of credit for lowincome, minority, or underserved communities, and the impact that the failure of such company would have on the availability of credit in such communities;

2.

3.

4.

d.

e.

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f.

the extent to which assets are managed rather than owned by the company, and the extent to which ownership of assets under management is diffuse; the nature, scope, size, scale, concentration, interconnectedness, and mix of the activities of the company; the degree to which the company is already regulated by 1 or more primary financial regulatory agencies; the amount and nature of the financial assets of the company; the amount and types of the liabilities of the company, including the degree of reliance on short-term funding; and any other risk-related factors that the Council deems appropriate. See 113(a)(2).

g. h. i. j. k. II.

Commencement of Orderly Liquidation A. Recommendation and Determination 1. The Act requires that the Board of Governors and the Federal Deposit Insurance Corporation (the Corporation) consider, either at their own initiative or at the request of the Secretary of the Treasury (the Secretary), whether to make a written recommendation (the Recommendation) as to whether the Secretary should appoint the Corporation as the receiver of a financial company. a. The Recommendation must be made upon a vote of not less than two-thirds of the members of both the Board of Governors and Corporation. If the decision involves a financial company that is a broker/dealer, or whose largest U.S. subsidiary is a broker/dealer, the Securities Exchange Commission (the Commission) replaces the Corporation as the appropriate federal agency to make the Recommendation along with the Board of Governors (the two-thirds voting requirements are the same). If the decision involves a financial company that is an insurance company, or whose largest U.S. subsidiary is an insurance company, then the Director of the Federal Insurance Office shall make the Recommendation together

b.

c.

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with the two-thirds majority of Board of Governors. See 203(a)(1). d. The Recommendation must contain the following: (i) (ii) An evaluation of whether the financial company is in default or danger of default. A description of the effect that a default of the financial company would have on the economic condition or financial stability of the United States. A description of the effect that the default would have on the economic condition or financial stability for low-income, minority, or underserved communities. A recommendation regarding the nature and extent of actions to be taken under Title II. An evaluation of the likelihood of private sector alternatives to prevent a default of the financial company. An evaluation of why a case under the Bankruptcy Code is not appropriate. An evaluation of the effects on creditors, counterparties, and shareholders of the financial company and other market participants.

(iii)

(iv) (v)

(vi) (vii)

(viii) An evaluation of whether the company satisfies the definition of financial company. See 203(a)(2). 2. Based on the Recommendation, the Act requires that the Secretary take the necessary action to place a financial company in Orderly Liquidation if the Secretary makes a determination, in consultation with the President of the United States (the Determination), that: a. b. The financial company is in or in danger of default. Failure and its resolution under applicable Federal or State law would have serious adverse effects on the financial stability of the United States. No viable private sector alternative is available to prevent the default of the financial company.

c.

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d.

Any effect that an Orderly Liquidation under this title would have on claims or interests of creditors, counterparties, and shareholders of the financial company and other market participants is appropriate, given the impact that an Orderly Liquidation would have on the financial stability of the United States. Action under this title would avoid or mitigate such adverse effects on the United States, taking into consideration the effectiveness of the action in mitigating potential adverse effects on the financial system, the cost to the general fund of the Treasury, and the potential to increase risk taking by creditors, counterparties, and shareholders of the financial company. A Federal regulatory agency has ordered the financial company to convert all of its convertible debt instruments. The financial company satisfies the definition of financial company under section 201. See 203(e)(4).

e.

f. g. B.

Acquiescence Or Petition To The District Court 1. Subsequent to the Determination, the Secretary must notify the Corporation and the covered financial company of the Determination. The Secretary is then required to ask the companys board of directors whether it acquiesces to Corporations receivership. If the covered financial company acquiesces or consents to the appointment of the Corporation as receiver, then the Secretary must appoint the Corporation as receiver. Directors who consent to the appointment of the Corporation as receiver bear no liability for making this choice. If the covered financial company does not acquiesce or consent, then the Secretary shall petition the United States District Court for the District of Columbia (the Court) for an order authorizing the Secretary to appoint the Corporation as receiver. a. The Court has 24 hours to respond to the Secretarys petition before an order appointing the Corporation as receiver will be deemed automatically granted by that court. On a strictly confidential basis: (i) the Court must hold a hearing, after notice to the covered financial company and an opportunity to oppose the petition; and (ii) determine 5

2.

3.

b.

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whether the Determination by the Secretary is arbitrary and capricious. (a) If the Court determines that the Determination is not arbitrary and capricious, then the Court must issue an order authorizing the Secretary to appoint the Corporation as receiver. If the Court determines that the Determination is arbitrary and capricious, then the Court must provide the Secretary with a written statement of each reason supporting its determination and afford the Secretary an opportunity to amend and re-file the petition. If the Court does not make a determination within 24 hours of receipt of the petition, then the petition is granted by operation of law, the Secretary shall appoint the Corporation as receiver, and the Orderly Liquidation shall commence automatically. See 202(a)(1)(A).

(b)

(c)

c.

The order commencing Orderly Liquidation may be appealed by the Secretary or the covered financial company to the Court of Appeals for the District of Columbia on an expedited basis, but is not subject to a stay or injunction pending appeal, thus making a lengthy appeals process unrealistic in most circumstances. Review is limited to whether the Determination by the Secretary was arbitrary or capricious. A petition for a writ of certiorari to review a decision of the Court of Appeals may be filed by the Secretary or the covered financial company. See 202(a)(2)(A) (B).

d.

III.

Orderly Liquidation of Broker Dealers A. If the covered financial company is a broker dealer, the Corporation must appoint the Securities Investor Protection Corporation (SIPC) to act as trustee (the SIPC Trustee) under the Securities Investor Protection Act of 1970 (15 U.S.C. 78aaa et seq.) (SIPA). After being appointed, the SPIC Trustee must petition the United States District Court of competent jurisdiction to issue a protective decree and commence a liquidation under SIPA.

B.

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C.

Upon entry of a protective decree, the liquidation of the covered broker dealer shall be administered under SIPA, and the SPIC Trustee shall have all the powers and duties of a trustee under SIPA. However, the SPIC Trustees powers shall not impair or impede the exercise of the powers and duties of the Corporation to 1. 2. 3. 4. 5. make funds available; organize a bridge institution; transfer assets and liabilities; enforce or repudiate contracts; or take any other action relating to a bridge financial company. See 205.

D.

IV.

Orderly Liquidation A. Applicable law 1. No provisions of the Bankruptcy Code and Bankruptcy Rules apply to a covered financial company in Orderly Liquidation under Title II. See 202(c). Rehabilitation and reorganization are not permitted. Unlike chapter 11 of the Bankruptcy Code, the covered financial company does not remain in possession of its assets and businesses; in all cases, the Corporation assumes full control of the covered financial company. All existing bankruptcy or other insolvency cases are dismissed, and no other such case may be filed against the company during the liquidation process.

2. 3.

4.

B.

Time Limit 1. The Corporations appointment terminates at the end of three (3) years, but may be extended a. for up to one additional year if the Chairperson of the Corporation determines and certifies in writing to the Senate Committee on Banking, Housing, and Urban Affairs and the House Financial Services Committee that continuation of the receivership is necessary (i) to maximize value and minimize

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loss from the liquidation of the covered financial company, and (ii) to protect the stability of the U.S. financial system; and b. for a second additional year if the certification described above is resubmitted with the concurrence of the Secretary. See 202(d)(1)-(3).

2.

The Corporation must submit a report and a specific plan to conclude the receivership to the committees above no later than 30 days after the first one-year extension. See 202(d)(3). The time limit may be further extended solely for the purpose of completing ongoing litigation in which the Corporation, as receiver, is a party. See 202(d)(4).

3.

C.

Powers and Duties of the Corporation as Receiver 1. The Corporation succeeds to the rights, title, powers, and privileges of the financial company and operates the entity in order to maximize net asset sale value. The Corporation has many of the same receivership powers it has under the current banking laws, but those powers have been modified to address many of the differences between financial companies that pose a systemic risk and insured banks and thrifts in general. a. Upon appointment, the Corporation: (i) (ii) may make funds available for the orderly liquidation of the covered financial company, see 204(d); shall succeed to all rights, titles, powers, and privileges of the covered financial company, see 210(a)(1)(A)(i); may control, manage, and preserve assets, collect on accounts, perform functions, preserve assets, and contract for assistance, see 210(a)(1)(B); may liquidate the covered financial company, see 210(a)(1)(D); may appoint itself as receiver of the covered financial companys subsidiaries, see 210(a)(1)(E);

2.

(iii)

(iv) (v)

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(vi) (vii)

may organize a bridge company, see 210(a)(1)(F); may merge the covered financial company with another company or transfer the assets or liabilities of the covered financial company without obtaining any approval, assignment, or consent with respect to such transfer (other than the operation of applicable law, such as antitrust law),1 see 210(a)(1)(G);

(viii) may pay obligations of the covered financial company, see 210(a)(1)(H); (ix) shall terminate all rights and claims that stockholders and creditors of the covered financial company have against the assets of the covered financial company arising out of their status as stockholders or creditors, except for their right to payment as permitted under Title II, see 210(a)(1)(M); may coordinate with appropriate foreign financial authorities, see 210(a)(1)(N); shall transfer customer accounts to a bridge financial company in the case of a broker/dealer, see 210(a)(1)(O); may enforce any contracts of the covered financial company, see 210(c)(13), or contracts of a covered financial companys subsidiaries or affiliates that are guaranteed, supported, or linked to the covered financial company (provided that (i) the guarantee and other support or related assets are transferred to a bridge financial company or third party that is not subject to any bankruptcy or insolvency proceeding and (ii) the Corporation provides adequate protection with respect to such obligation). See 210(c)(16). (a) The authority to enforce contracts is not affected by any provision providing for the termination, default, acceleration, or exercise of rights upon, or solely by reason of,

(x) (xi)

(xii)

If a merger requires Federal agency approval, the transaction may not take place until 5 days after approval. If a report is required, the Federal agency will ask the Attorney General to issue a report, which will be issued within 10 days of the inquiry. If a merger requires a filing with the Department of Justice or Federal Trade Commission, a 30-day waiting period will be imposed.

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insolvency, the appointment of or exercise of rights or powers by the Corporation as receiver, the filing of a petition under section 201(a)(1), or the issuance of the Recommendation or Determination, or any actions or events occurring in connection therewith or as a result thereof. See 210(c)(13)(A); 210(c)(16)(A). (b) Ipso facto clauses that provide for the power to terminate, accelerate, or declare a default, or to obtain possession of or exercise control over any property of or affect the rights of a covered financial company, may not be exercised without the Corporations consent during the first 90 days after the Corporations appointment. See 210(c)(13)(C). If the Corporation enforces a contract to extend credit, the obligation to repay that arises shall be paid as an administrative expense of the receivership. See 210(c)(13)(D).

(c)

(xiii) may repudiate contracts, but not without curing or providing adequate assurance that it will cure any defaults. See 210(c)(1). (a) The Corporation shall determine whether or not to exercise the right of repudiation within a reasonable period of time. See 210(c)(2). Claims arising therefore are limited to actual direct compensatory damages determined as of the date of appointment of the Corporation as receiver. See 210(c)(3)(A)(i)(I). In the case of qualified financial contracts (i.e., derivatives), claims are measured as of the date of repudiation. See 210(c)(3)(A)(i)(II). In the case of debt obligations, which are also subject to repudiation, damages shall be no

(b)

(c)

(d)

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less than the amount lent plus accrued interest or accreted original issue discount as of the date of appointment of the Corporation. To the extent that a claim is oversecured, interest may continue to accrue up to the value of the security. See 210(c)(3)(D). (e) In the case of contingent obligations, the Corporation may (by rule or regulation) estimate the claim as of the date of the Corporations appointment. See 210(c)(3)(E). In the case of leases where the covered financial company is the lessee, the lessor shall be entitled to a claim for the contractual rent accrued before repudiation, for unpaid rent due as of the date of the Corporations appointment, and no claim for damages under an acceleration or penalty provision. See 210(c)(4)(B). In the case of leases where the covered financial company is the lessor, the lessee, if not in default, may either (i) treat the lease as terminated by the Corporations repudiation, or (ii) remain in possession for the balance of the lease term, unless the lessee defaults, in which case the lessee shall continue to pay rent. See 210(c)(5). In the case of contracts for the sale of real property, the purchase, if not in default, may either (i) treat the contract as terminated by the Corporations repudiation, or (ii) remain in possession of the property, in which case the purchaser shall continue to make all payments due, and the Corporation (i) shall not be liable for damages from its repudiation, (ii) shall deliver title to the purchase in accordance with the contracts terms, and (iii) shall have no other obligation under the contract. See 210(c)(6).

(f)

(g)

(h)

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(i) In the case of service contracts, claims shall be deemed to have arisen as of the date of the Corporations appointment. See 210(c)(7). Any judgment for money damages entered against the Corporation as receiver for the breach of a contract executed or approved by the Corporation after its appointment shall be paid as an administrative expense. See 210(c)(15).

(j)

3.

As receiver, the Corporation is required to consult with: a. the primary financial regulatory agency or agencies with oversight over the covered financial company and its subsidiaries, (i) to ensure an orderly liquidation of the covered financial company and (ii) regarding the treatment of the covered financial companys solvent subsidiaries; and with the Commission and the SIPC if the covered financial company is a broker/dealer.

b. 4. 5.

The Corporation may also retain and consult outside experts. See 204(c). No later than 60 days after being appointed as receiver, the Corporation must prepare quarterly reports on the assets and liabilities of the covered financial company, file them with the committee on banking, housing, and urban affairs in the senate, and the committee on financial services in the house. The Corporation must also publish the reports in a website that the Corporation maintains. See 203(c)(3). Certain mandatory terms and conditions apply to the Corporations actions as receiver. a. Before taking any action, the Corporation must determine that such action is necessary for purposes of the financial stability of the United States, and not for the purpose of preserving the covered financial company. The Corporation must ensure that (i) shareholders of the covered financial company do not receive payment until all other claims and the Orderly Liquidation Fund (defined below) are fully paid, and (ii) unsecured creditors bear losses in accordance with the priority of claims provisions of section 210. See 206(1) (3). 12

6.

b.

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c.

The Corporation must also ensure that management and members of the board of directors responsible for the companys failure are removed, see 206 (4) (5), and may recover from any current or former senior executive or director substantially responsible for the companys failure any compensation received during the two-year period preceding the date of the Corporations appointment (in the case of fraud, no time limit applies), see 210(s).

V.

Determination of Claims A. The Corporation has complete discretion to allow or disallow claims 1. The Corporation must promptly publish a notice for creditors to present their claims, together with proof, by a specified date at least 90 days after the notice is published. See 210(a)(2)(B)(i). a. b. The notice should be republished one month, and then two months later. See 210(a)(2)(B)(ii). Within 180 days after a claim is filed, the Corporation must notify a claimant as to whether it allows or disallows a claim. See 210(a)(3)(A)(i). The 180 day period may be extended by written agreement between the Corporation and the claimant. See 210(a)(3)(A)(ii). Failure to notify the claimant of any disallowance within 180 days shall be deemed to be a disallowance of such claim. See id.

c.

2.

The Corporation may allow any claim that is proven to the Corporations satisfaction, see 210(a)(3)(B), and disallow any portion of any claim that is not proven to the Corporations satisfaction, see 210(a)(3)(D)(i), and may bifurcate claims, treating any oversecured portion as unsecured, see 210(a)(3)(D)(ii). A claimant may then file a suit on a claim, or continue an action commenced before the appointment of the Corporation, in the district or territorial court of the United States for the district within which the principal place of business of the covered financial company is located (and such court shall have jurisdiction to hear such claim). See 210(a)(4)(A).

3.

B.

The Corporation may establish expedited claims determination procedures for claimants who allege a valid and perfected security interest and that irreparable injury will occur if the ordinary claims procedure is followed. See 210(a)(5). 13

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C. The Corporation is also authorized to pay creditor claims which are either (i) allowed, (ii) determined through expedited procedures, or (iii) determined by the final judgment of a court of competent jurisdiction. See 210(a)(7)(A). The Act provides that no court shall have jurisdiction over any claim or action for payment from, or any action seeking a determination of rights with respect to, the assets of any covered financial company for which the Corporation is a receiver, or any claim relating to any act or omission of such covered financial company or the Corporation as receiver. See 210(a)(9)(D). Unsecured claims have priority in the following order: 1. 2. 3. 4. 5. 6. 7. VI. Corporation's expenses as receiver Amounts owed to the United States Up to $11,725 in wages, salaries, commissions, or benefits earned by individual employees General liabilities Obligations subordinated to general creditors Wages, salaries, or commissions owed to senior management and directors Interests of shareholders, members, and general or limited partners. See 210(b)(1).

D.

E.

Suspension of Legal Action A. The Corporation, after its appointment, may request a stay of any judicial action or proceeding in which the financial company is or becomes a party, for a period not to exceed 90 days, which request the court shall grant as to all parties. See 210(a)(8).

VII.

Derivatives A. B. The Act contains the same safe harbors that exist in the Bankruptcy Code. The Act provides for a grace period, until 5:00 p.m. on the business day after the Corporations appointment, within which counterparties may not exercise any contractual right to terminate, accelerate, or liquidate their contracts.

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1.

During this time, payment and delivery obligations are also suspended, and the Corporation may transfer all of qualified financial contracts between the financial company and a particular counterparty (and all of the counterparties affiliates). a. b. Such transfer may only be made to the same transferee. Upon a counterpartys receipt of a notice of transfer, the counterparty may no longer exercise the termination rights that are otherwise safe-harbored.

2.

If the Corporation decides to repudiate the covered financial companys qualified financial contracts with a particular person or affiliate of such person, all or none of the qualified financial contracts between the Corporation and such person or affiliate of such person may be repudiate. See 210(c)(8).

VIII.

Orderly Liquidation Fund A. The Act provides for the creation of an Orderly Liquidation Fund in Treasury, separate and distinct from the Deposit Insurance Fund, to be managed by the Corporation. See 210(n)(1), (3). 1. Funds are to be raised first through assessments on any claimant that received additionally payments in excess of the amount such claimant would have received under chapter 7 of the Bankruptcy Code, and, then, if necessary, through risk-based assessments (i.e., taking into account general economic conditions) at a graduated rate based on the size of eligible financial companies, i.e., bank holding companies with total consolidated assets of $50 billion. See 210(o). The funds from the Orderly Liquidation Fund are available for the Corporations use only after the Corporation has developed an orderly liquidation plan that is acceptable to the Secretary. See 210(n)(9).

2.

B.

The Corporation is authorized to issue obligations to the Secretary for the purpose of funding an orderly liquidation, and that the Secretary is authorized to purchase such obligations and use, as a public debt transaction, the proceeds of sale of public debt securities for such purchase. See 210(n)(5). 1. The terms of the Corporations borrowings from the Treasury and the rate of return are to be determined by the Secretary. See 210(n)(5)(C).

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2. The obligations issued to the Secretary are not to exceed 10% of the assets of the covered financial company for which the obligation is issued, or 90% of the fair value of assets from each covered financial company to which the Corporation is appointed as receiver. See 210(n)(6).

IX.

Commentary A. The Goal of the Dodd-Frank Act

The Dodd-Frank Act was, in essence, enacted to address the increasing propensity of the financial sector to put the system at risk and be eventually bailed out at taxpayer expense.2 The legislation was enacted to give regulators better tools to deal with increasingly large and interconnected financial firms whose very existence create systemic riskthe risk that the collapse of one financial institution may cause or contribute to the failure of others in a chain-like manner due to their interconnectedness.3 Thus, for example, it is said that when Lehman Brothers failed, money market funds that held Lehman commercial paper (short-term, unsecured debt) marked down the value of these holdings, leading to investor redemptions, further forcing funds to sell assets into the market at depressed prices, in the process of which, caused the well-known Reserve Primary Fund to break the buck, which further precipitated a run on funds and froze the commercial paper market until the Federal Reserve intervened by guaranteeing money market funds.4 During the recent financial crisis, regulators witnessed first-hand that systemic effects can be brought about by financial companies other than insured depositary institutions, which are banks. 5 Yet, unlike banks, which are governed under the Federal Deposit Insurance Act (the FDIA), 6 such financial companies were beyond the2

Viral V. Acharya, Failures of the Dodd-Frank Act, FT.Com, July 15 2010, available at http://www.ft.com/cms/s/0/ccbb38ea-9010-11df-91b6-00144feab49a.html. Ha. S. Scott, The Reduction of Systemic Risk in the United States Financial System, 33 Harv. J. L. & Pub. Poly 671, 673 (2010). Kenneth Ayotte & David A. Skeel, Jr., Bankruptcy or Bailouts, 35 J. Corp. L. 469, 488 (2010). Theo Francis, Geithner Outlines Resolution Authority, Businessweek, Mar. 25, 2009, available at http://www.businessweek.com/bwdaily/dnflash/content/mar2009/db20090325 _426418.htm. Even after the enactment of the Dodd-Frank Act, banks remain subject to the FDIA and are not subject to the liquidation authority of the Dodd-Frank Act.

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resolution authority of regulators. According to the Treasury Department, the only options which it had during the recent financial crisis to deal with a non-bank financial company in severe distress was to either (i) stabilize the financial company with outside capital or funding from the US government at taxpayer expense, such as the case with AIG, or (ii) allow the financial company to fail, which could result in systemic effects causing damage to the financial markets, such as the case with Lehman Brothers.7 B. The Problem with Bailouts

During the occurrence of a financial crisis, the utilization of public funds by regulators to stabilize a financial company is an effective means by which to mitigate the occurrence of systemic effects. Much of the systemic effect that can damage financial markets is due to the realization of losses by counterparties and creditors of a defaulting financial company, and can be prevented by the use of funds to shield counterparties and creditors from the realization of such losses. 8 Thus, it is said that, during the recent financial crisis, AIG owed its counterparties a significant amount of collateral payments, and if AIG had not been bailed-out by regulators, certain of its counterparties may have failed along with AIG.9 Instead of providing a bailout to AIG, regulators could also have made direct payments to AIGs counterparties, which, assuming all other things were equal, would have significantly reduced the consequences of AIG failing.10 There are several reasons why government funded bailouts are not a sustainable means to address systemic risks. First, even while such bailouts can be structured so that the government can generate substantial profit if the financial condition of the bailed-out company improves, such bailouts are politically unpopular as they place taxpayer dollars at risk.11 Secondly, bailouts could potentially preserve the existence of inefficient companies that should otherwise be restructured or liquidated.12 Third, moral hazard is created for the stakeholders of a bailed-out company, such as where counterparties forgo market disciple and provide the financial company with an artificially low cost of capital, which would7

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cause the financial company to grow quickly and become increasingly expensive to bailout.13 C. The Problem with Bankruptcy

Bankruptcy has shown itself to be a very capable mechanism to bring about the orderly resolution of claims against and equity interests in a wide spectrum of debtors. When faced with extreme time pressures, bankruptcy judges, lawyers and parties in interest have acted swiftly to maximize value, as in the cases of Drexel Burnham and Lehman Brothers.14 In fact, Lehmans North American investment banking business was sold to Barclays just three days after the bankruptcy case commenced. Nevertheless, some have argued that, while bankruptcy may not necessarily cause systemic risk,15 it currently does little to mitigate it. Thus, the bankruptcy of a large financial company may cause, among other things, (i) certain counterparties to bear such losses that it fails, which, in turn, may have repercussions for the broader financial markets, (ii) the bankrupt company to engage in fire sales of its financial assets, which would harm and possibly result in the failure of other financial firms holding similar assets,16 and (iii) certain sellers of credit default swaps of the bankrupt companys debt to make large payments to its counterparties, which may destabilize the seller.17 The principles underlying bankruptcy (and the statutory provisions intended to implement those objective) are flexible enough to protect against systemic risk while allowing for the reorganization or liquidation of a financial company, but amendments would have to be made to existing bankruptcy law to achieve that result. For example, the traditional goal of bankruptcy is to maximize the value of the estate for the benefit of its stakeholders. Such a goal is not necessarily consistent with the goals of the Dodd-Frank Act, which has the primary objective to mitigate systemic risk for the benefit of the financial system, even, to a large extent, at the expense of the firms stakeholders. In order to protect the integrity of the financial system, there may be occasions where certain creditors and counterparties may need to be shielded from losses (at least temporarily) and treated unequally from others similarly situated, because, if such favored creditors and13

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counterparties failed, the feared chain reaction of failures may result and devastate the financial system.18 While bankruptcy is flexible enough to grant priority to certain parties in interest, such as the case with critical vendors, existing bankruptcy law may require significant amendment to prioritize creditors for the benefit of the national interest. Additionally, in order for bankruptcy to be used to prevent systemic effects and to reorganize or liquidate a financial company, the government will likely be required to participate in every bankruptcy case. The cost of stabilizing a financial company can be significant, and as recognized by Geithner, generally, [i]n a crisis, there is no plausible private source of temporary financing, like debtor in possession financing for companies in bankruptcy.19 Even fewer lenders would be willing to provide a debtor financing to shield certain counterparties from losses for the good of the financial markets. Even still, the government successfully provided financing for the bankruptcy cases of General Motors and Chrysler, both of which, while not companies in the financial sector, were regarded as companies falling within the too big to fail category. D. Analysis of the Dodd-Frank Act 1. Systemic Risks

In theory, the Dodd-Frank Act should reduce systemic risk. Much of the systemic effect which regulators seek to address is due to the realization of losses by counterparties and creditors to a failing financial company. 20 To the extent that the Dodd-Frank Act affords regulators a sufficient source of funds to prevent the realization of such losses and to delay the need to conduct a fire sale of assets, the Dodd-Frank Act will reduce systemic risk. However, the extent to which the new legislation reduces the risk of bank runs is unclear. In Bear Stearns case, it said that rumors of the investment banks liquidity problems lead to massive withdrawals of funds by its clients and the refusal of its counterparties to supply overnight credit through repurchase agreements, such that, within a short period of time, Bear Stearns could not fund its obligations.21 While the more stringent regulatory requirements of the Dodd-Frank Act will decrease the chances that18

ABI/NYU BANKRUPTCY AND BUSINESS REORGANIZATION WORKSHOP ADVANCED PROGRAM

such rumors will develop, presumably, counterparties and investors will in certain circumstances continue to engage in bank runs. The reason why is because even if counterparties and investors would be protected from losses through the Dodd-Frank Act, there can be no assurance that the legislation will be utilized in any given case because its application depends upon, among other things, a decision by regulators as to whether the financial markets are sufficiently robust at present to withstand the failure of the covered financial company in question. It was essentially this sort of rationale which prompted regulators to allow Drexel Burnham to enter into bankruptcy during a calm period while, during another period, Long Term-Capital Management was treated as systemically important because of the Southeast Asian Currency Crisis. 22 The extent to which the Dodd-Frank Act can prevent a bank run or any other systemic effect during the onset of a crisis may depend on the speed at which regulators act to contain the situation. In that regard, it is desirable that regulators now have the ability to determine when to place a covered financial company into receivership, given that, while management may have more information on the level of distress of the company, management may be inclined to wait too long in the interest of stakeholders. It has been recognized that speed is one of the advantageous of using this sort of resolution authority over bankruptcy.23 However, in practice, it is uncertain how soon regulators will place a distressed firm into receivership, as the decision will have significant consequences not only for the stakeholders of the distressed firm, but may also prematurely foster panic in the financial markets. 2. The Institutionalization of Bailouts

One of the most common criticisms levied at the Dodd-Frank Act, even after it became apparent that the Orderly Liquidation Fund would not be pre-funded, is that the legislation would institutionalize bailouts.24 However, while the Orderly Liquidation Fund utilized to stabilize and eventually liquidate a covered financial company will initially be funded through the sale of government securities, such funds will ultimately be repaid from the stakeholders in the covered financial company and, to the extent of any deficiency, the financial sector, through the use of the risk-based assessments. As such, it is likely that the Dodd-Frank Act will end bailouts, at least from the perspective of taxpayers. However, the surviving financial companies required to pay the assessments may regard it as unfair that they be required to pay for the failure of a firm that may have been22

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irresponsibly managed. While the assessment to be paid by any particular firm will be based upon the risk inherent in such firm (as measured by the risk matrix) any measure of risk will inevitably be somewhat subjective. Moreover, the actual amount which any financial company will have to pay due to risk-based assessments may be quite significant depending upon the severity of the failure(s) and such assessments may have to be paid at a time when the financial sector as a whole is experiencing distress. Because the assessments are risk-based, the financial firms which are the most distressed may be required to pay the greatest amounts. It is unclear whether the incurrence of such liability may itself contribute to the failure of a financial firm. Additionally, while taxpayers are no longer bearing the risk associated with a bailout, it is uncertain whether taxpayers will be forced to indirectly pay for the DoddFrank Act as a result of financial companies passing increased costs of business under the regulations on to consumers, or, as a result of the government receiving less tax revenue due to financial companies generating less profit under the regulations. 3. Derivatives

The Dodd-Frank Acts treatment of derivatives under the Orderly Resolution Authority has significant advantageous over existing bankruptcy law. Under the DoddFrank Act, after a financial company has been placed into receivership by regulators, counterparties of derivatives with the financial company are not permitted to exercise any contractual right to terminate, accelerate or liquidate their contracts until 5:00 pm of the next business day. Before such time, if the regulator transfers the derivative contract, then the counterparty will generally be unable to exercise its right to terminate. Under bankruptcy law, counterparties of derivatives with the debtor are not subject to the automatic stay and may immediately close out their contracts under the rationale that counterparties need to re-hedge their risks or else significant ripples effects can develop through the financial markets.25 When Lehman Brothers field for bankruptcy, 700,000 of its 900,000 derivatives contracts were canceled by counterparties. The simultaneous closing of so many contracts potentially resulted in significant loss of value for the estate and threatened chaos in the derivatives market.26 4. Miscellaneous a. The Abandoned Attempt to Involve the Bankruptcy Courts

As enacted, the Dodd-Frank Act requires that the District Court for the District of Columbia to rule on the petitions of the Secretary of the Treasury for authorization to25

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appoint a regulator as the receiver for a failing financial firm. Under a prior bill, the Delaware Bankruptcy Court would have been required to rule on such petitions.27 In connection thereto, the Committee of the Judiciary of the U.S. Senate sought the views of the Judicial Conference of the United States, which expressed certain concerns with the prior bill. Specifically, the Judicial Conference stated that as the proposed bill contemplated for the possibility that certain bankruptcy cases would be transferred to receivership, it was concerned about the affect such transfer would have on prior court rulings.28 Additionally, the Judicial Conference commented that a ruling on the petition of the Secretary of Treasury for the appointment of a receiver was akin to a ruling on an agency decision, and as such, may not be constitutional unless decided by an Article III judge.29 b. Moral Hazard

As alluded to earlier, under the Dodd-Frank Act, not every distressed financial company will be placed under receivership, since, the legislation specifically contemplates that bankruptcy is ordinarily the proper mechanism to deal with the failure of a firm. This level of uncertainty over whether regulators will intervene to protect the losses of certain counterparties and creditors can have the effect of fostering panic, which, under certain situations, can precipitate into a run on the financial company. However, such uncertainty can also have the effect during normal times of reducing the risk of moral hazard. As a result of the uncertainty, counterparties and creditors are more inclined to maintain market discipline.30

27

Letter from James C. Duff, Secretary of the Judicial Conference of the U.S., to Patrick Leahy, Chairman of the Committee of the Judiciary, U.S. Senate (April 12, 2010), available at http://frwebgate.access.gpo.gov/cgibin/getpage.cgi?position=all&page=S2575 &dbname=2010_record Id. Id. Alison M. Hashmall, Note, After the Fall: A New Framework to Regulate Too Big To Fail Non-Bank Financial Institutions, 85 N.Y.U.L. Rev. 829, 849 (2010).

American Bankruptcy Institute

ABI/NYU BANKRUPTCY AND BUSINESS REORGANIZATION WORKSHOP ADVANCED PROGRAM

Receivership Provisions of Dodd-Frank Wall Street Reform and Consumer Protection ActHarold S. Novikoff Gregory E. Pessin The Orderly Liquidation Authority contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act), Sections 201 through 209 of the Act,1 12 USC 5381-94, represents a melding of provisions and concepts borrowed from the Federal Deposit Insurance Act (the FDIA) and the Bankruptcy Code designed to maximize the value obtained from the assets of a failing major financial company and to minimize the effects of its failure on the financial system. Following FDIA concepts, the Act authorizes the appointment of the Federal Deposit Insurance Corporation (the FDIC) as receiver for a covered financial company to conduct the orderly liquidation of the covered financial company, including broad authority to transfer the business and assets of the covered financial company to another financial firm or a bridge financial company created by the FDIC, all with minimal court involvement. With respect to matters such as a treatment of contracts, avoidance of transfers, obtaining credit and treatment of creditors, the Act more closely resembles the Bankruptcy Code. In the case of broker-dealers, the Act injects an overlay of customer protections from the Securities Investor Protection Act (SIPA). This Outline summarizes the provisions of the Act governing the conduct of receiverships of covered financial companies and related matters, Sections 210-17. An accompanying article discusses Sections 201-209 of the Act governing the commencement of an orderly liquidation proceeding. I. Orderly Liquidation; Powers and Duties of FDIC, as Receiver A. Orderly Liquidation. The FDIC shall, as receiver for a covered financial company liquidate, and wind-up the affairs of a covered financial company, including taking steps to realize upon the assets of the covered financial company, in such manner as the [FDIC] deems appropriate, including through the sale of assets, the transfer of assets to a bridge financial company established under [Section 210(h)], or the exercise of any other rights or privileges granted to the receiver under [Section 210], Section 210(a)(1)(D). 1. The Act contemplates a receivership or, in bankruptcy parlance, a liquidation. See Section 214(a). The business of the covered financial company will con1

Unless otherwise specified, Section references are to the Act.

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tinue permanently only if it is transferred to a bridge financial company or other acquiror, or merged with another entity. 2. The conduct of the receivership is subject to all legally enforceable and perfected security interests and all legally enforceable security entitlements in respect of assets held by the covered financial company. 3. The FDIC, as receiver, shall to the greatest extent practicable: a. maximize the net present value return from the sale or disposition of the covered financial companys assets; b. minimize the amount of any loss realized in the resolution of cases; c. mitigate the potential for serious adverse effects to the financial system; d. ensure timely and adequate competition and fair and consistent treatment of offerors; and e. prohibit discrimination on the basis of race, sex or ethnic group in the solicitation and consideration of offers, Section 210(a)(9)(E). 4. The FDIC, as receiver, shall coordinate, to the maximum extent possible with foreign financial authorities regarding the orderly liquidation of any covered financial company that has foreign assets or operations, Section 210(a)(1)(N). B. Receiver as Successor to Covered Financial Company. Upon its appointment as receiver of a covered financial company, the FDIC succeeds to: 1. all rights, titles, powers and privileges of the covered financial company and its assets;

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2. all rights, titles, powers and privileges of any stockholder, member, officer or director of the covered financial company; and a. Therefore, the receiver does not require board or shareholder consent or approval for any action. b. The FDIC, as receiver, shall terminate all rights and claims that stockholders and creditors of the covered financial company may have against the assets of the covered financial company arising out of their status as stockholders or creditors, except for their right to payment, resolution or other satisfaction as permitted under Section 210, Section 210(a)(1)(M). This would appear to be subject to valid security interests, security entitlements and interests in customer property, Section 210(a)(1)(D) and (c)(12). c. The [FDIC] shall ensure that shareholders and unsecured creditors bear losses, consistent with the priority of claims provisions under [Section 210], Section 210(a)(1)(M). 3. title to the books, records and assets of any previous receiver or other legal custodian of the covered financial company, Section 210(a)(1)(A). C. Powers of Receiver. The FDIC, as receiver, may exercise all powers and

authorities specifically granted to receivers under the receivership provisions of the Act, and such incidental powers as are necessary to carry out such powers, Section 210(a)(1)(K). D. Operation of the Covered Financial Company During Orderly Liquidation. The FDIC, as receiver, may:

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1. take over the assets of the covered financial company and operate its business with all of the powers of the members, shareholders, directors and officers; 2. collect all amounts owed to the covered financial company; 3. perform all functions of the covered financial company in the name of the company; a. The FDIC may provide for the exercise of any function by any member, stockholder, director or officer, Section 210(a)(1)(C). 4. manage the assets and properties of the covered financial company, consistent with maximization of the value of the assets in the context of the orderly liquidation; and 5. contract for assistance in carrying out any function, activity, action or duty of the receiver, Section 210(a)(1)(B). a. The FDIC, as receiver, may utilize the private sector in connection with the management and disposition of assets, including real estate and loan portfolio asset management, property management, auction marketing, legal and brokerage services, Section 210(a)(1)(L). E. Failing Subsidiaries of a Covered Financial Company. The FDIC may appoint itself receiver of any subsidiary of a covered financial company if such subsidiary is organized under Federal law or the law of any state (unless such subsidiary is an insured depositary institution, an insurance company or a covered broker dealer), if the FDIC and the Secretary of the Treasury jointly determine that: 1. such subsidiary is in default or in danger of default (as defined in Section 203(c)(4));

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2. such action would avoid or mitigate serious adverse effects on the financial stability or economic conditions of the United States; and 3. such action would facilitate the orderly liquidation of the parent covered financial company, Section 210(a)(1)(E). F. Payment of Valid Obligations; Claims against Receiver. The receiver is required, to the extent funds are available, to pay all valid obligations of the covered financial company that are due and payable at the time of the appointment of the FDIC as receiver, Section 210(a)(1)(H). To that end, the Act provides that: 1. The Act, and not any provision of Federal or state law, governs the rights of the creditors of any covered financial company, Section 210(d)(1). 2. A creditor shall in no event receive less than the amounts described below (which amounts shall also constitute the maximum liability of the FDIC, as receiver, to any claimholder of a covered financial company), Section 210(a)(7)(B): a. With respect to a claimholder of a covered financial company, the amount that such claimant would have received if the FDIC had not been appointed as receiver of such covered financial company and the covered financial company had been liquidated under chapter 7 of the Bankruptcy Code or any similar provision of state insolvency law applicable to such covered financial company, Section 210(d)(2). b. With respect to any customer property of any customer of a covered broker or dealer, an amount equal to the amount that such customer would have received with respect to its customer property in a case initiated by

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the Securities Investor Protection Corporation (SIPC) under SIPA, determined as of the close of business on the date on which the FDIC is appointed as receiver, Section 210(d)(3). 4. Notwithstanding the foregoing provisions, the FDIC, with approval of the Secretary of the Treasury, may make additional payments to any claimant or any category of claimants of a covered financial company if the FDIC determines that such payments are necessary or appropriate to minimize losses to the FDIC as receiver from the orderly liquidation of the covered financial company, subject to the following limitations: a. No claimant may receive more than the face value amount of any claim that is proven to the satisfaction of the FDIC. b. The FDIC shall not be obligated, as a result of making any such payment to any claimant or category of claimants, to make payments to any other claimant or category of claimants, Section 201(d)(4). 5. No post-insolvency interest on claims against the receivership estate may be paid until the receiver has paid the principal amount of all creditor claims, Section 210(a)(7)(D). The interest rate applicable to post-insolvency interest is to be determined by FDIC rulemaking, Id. G. Priority of Claims. The Act does not affect the priority of secured claims or security entitlements in respect of assets of the covered financial company, except to the extent that such claim is undersecured,2 Section 210(a)(5). With respect to unsecured claims, the Act provides:

The Act bifurcates undersecured claims into secured and unsecured claim components in a manner similar to Bankruptcy Code 506(a). See Section 210(a)(3)(D)(ii).

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1. Unsecured claims against a covered financial company, or the FDIC, as receiver, shall have priority in the following order: a. Administrative expenses of the receiver. b. Amounts owed to the United States (unless it agrees otherwise). c. Wages, salaries or commissions, including vacation, severance and sick leave pay earned by an individual (other than any senior executive of the covered financial company), but only to the extent of $11,725 per individual (as indexed for inflation) earned not later than 180 days before the date of appointment of the FDIC as receiver. d. Contributions owed to employee benefit plans arising from services rendered not later than 180 days before the appointment of the FDIC as receiver, in an amount equal to the number of employees covered by each such plan, multiplied by $11,725 (indexed for inflation), minus the aggregate amount paid to employees under Paragraph I.G.1.c above, plus the aggregate amount paid by the receivership on behalf of such employees to any other employee benefit plan.3 e. Any other general or senior liability of the covered financial company (not otherwise described in clause (f), (g) or (h) below). f. Any obligation subordinated to claims of general creditors (not otherwise described in clauses (g) or (h) below).

This subsection, like much of Section 210(b)(1) is derived from Bankruptcy Code 507(a). While copying much of the language of Bankruptcy Code 507(a)(5), it failed to include some of the italicized clause dividers and, consequently, the final plus clause arguably increases the amount available for the priority whereas it was presumably intended to reduce it (as in Bankruptcy Code 507(a)(5)).

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g. Any wages, salaries or commissions, including vacation, severance and sick leave pay, owed to senior executives and directors of the covered financial company. h. Any obligation to shareholders, members, general or limited partners or other persons with interests in the equity of the covered financial company arising as a result of their status as equity holders, Section 210(b)(1). 2. In cases where the FDIC is appointed as receiver for a covered broker or dealer, unsecured claims shall have the priority described in Paragraph I.G.1 above, with the following exceptions: a. SIPC shall be entitled to recover its administrative expenses on an equal basis with the FDIC; b. the FDIC shall be entitled to recover, as an amount owed to the United States, any amounts paid to customers or to SIPC in respect of customer claims pursuant to Section 205(f) of the Act; c. If any amounts are paid out of the SIPC Fund established under SIPA, SIPC shall be entitled to a claim for such amounts that shall be junior to administrative expenses of the receiver and amounts owed to the United States, but senior to all other unsecured claims; and d. the FDIC may, after paying claims to customers as provided in the Act and SIPA, pay other claims to the extent that funds are available in accordance with the priorities described in Paragraph I.G.1 above, Section 210(b)(6).

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3. As a general rule, similarly situated unsecured creditors must be treated in a similar manner, but the Act allows the FDIC to treat similarly situated creditors differently (including by making payments to them) if: a. the FDIC determines that such action is necessary: i. to maximize the value of the assets of the covered financial company; ii. to initiate and continue operations essential to the implementation of the receivership or bridge financial company; iii. to maximize the present value return from the sale of the assets of the covered financial company; or iv. to minimize the amount of loss realized upon such sale; and b. all similarly situated claimants receive not less than they would have received in a liquidation under chapter 7 of the Bankruptcy Code (or similar state law liquidation) in the absence of the appointment of the FDIC as receiver, Section 210(b)(4). A similar provision governing the treatment of similarly situated creditors (including possible payments by the FDIC) is applicable in the context of bridge financial company transactions, Section 210(h)(5)(E). N.B. This is a key concept in the Acts balancing of the interests of creditors and the financial system. The FDIC is free to act quickly to preserve value and reduce systemic risk by pre-empting the bankruptcy process and effecting massive dispositions of the businesses and assets of the covered financial company essentially a Bankruptcy Code 363 sale without court approval. Creditors whose claims are not assumed by the transferee

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and are left behind in the receivership estate are entitled to recover no less than they would have recovered in a bankruptcy liquidation, but may receive less than the holders of claims assumed by the transferee. Because the FDICs sale may not have produced enough value to achieve that level of recovery for receivership creditors, the Orderly Liquidation Fund described below may be required to make up the difference. 4. If the FDIC, as receiver, is unable to obtain unsecured credit for the covered financial company from commercial sources, the FDIC may obtain credit or incur debt on behalf of the covered financial company, which shall have priority over all administrative expenses of the receiver, Section 210(b)(2). 5. In the event that the receiver breaches an agreement executed or approved during the receivership, any monetary damages in respect thereof shall be paid as an administrative expense of the receiver, Section 210(a)(15). H. Claims Procedures. The FDIC, as receiver, must promptly publish and mail a notice to all creditors to present proofs of claim to the receiver by a specified date, which may be no earlier than 90 days after the publication of such notice, Section 210(a)(2)(B, C). After such publication and mailing, creditors must follow the following procedures with respect to their claims: 1. With certain exceptions, a creditor must file its claim by the date specified in the FDICs notice, or such claim will be disallowed, Section 210(a)(3)(C). 2. Within 180 days after a creditor files its claim, the FDIC must notify the creditor whether it accepts or objects to the claim, Section 210 (a)(3)(A)(i).

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3. The FDIC may object to any portion of any claim, or claim of a lien, preference, setoff or priority that is not proved to the FDICs satisfaction, other than any extension of credit from any Federal reserve bank or the FDIC to any covered financial company and any legally enforceable and perfected security interest relating to any such extension of credit, Section 210(a)(3)(D). 4. In the event that the FDIC objects to a claim, the creditor may file suit on such claim (or continue an action on such claim commenced before the appointment of the receiver) in the district court of the United States for the district where the principal place of business of the covered financial company is located. The creditor must commence or continue such action before the end of the 60-day period beginning on the earlier of (a) the date that is 180 days following the publication of the notice described in Paragraph I.H.2 above and (b) the date that the receiver notifies such claimant that it is objecting to the claim, Section 210(a)(4). 5. Any creditor that alleges (a) that it holds a perfected security interest in the property of the covered financial company or is an entitlement holder with control of any enforceable security entitlement in respect of any asset held by the covered financial company and (b) that irreparable injury will occur if the claims procedure described above is followed, has the right to an expedited determination of its claims, in accordance with the following procedures: a. Within 90 days after the creditor files its claim, the FDIC must determine whether to allow or disallow the claim, and whether the claim should be determined pursuant to the expedited process.

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b. Any claimant who files a request for expedited relief may file suit to determine its rights with respect to its security interest after the earlier of (a) the expiration of the 90-day period following its request for expedited relief and (b) the FDICs denial of the claim, Section 210(a)(5). I. Legal Actions. The Act sets forth a series of rules relating to legal actions against the covered financial company, as well as legal actions by the covered financial company and the FDIC, as receiver, including the following: 1. Following its appointment as receiver, the FDIC may request (and upon such request, courts must grant), a 90-day stay of any judicial action to which the covered financial company is or becomes a party, Section 210(a)(8). No attachment or execution can be issued by any court on assets in the FDICs possession as receiver, Section 210(a)(9)(C). 2. The FDIC will succeed to the rights and remedies available to the covered financial company with respect to all appealable judgments entered against the covered financial company prior to the FDICs appointment as receiver, and shall not be required to post any bond to pursue such remedies, Section 210(a)(9). The FDIC must abide by any final, nonappealable judgment entered against the covered financial company prior to the FDICs appointment as receiver. 3. The statute of limitations for any action brought by the receiver shall be: a. In the case of contract claims, the longer of (i) the period under applicable state law and (ii) the 6-year period beginning on the later of (X) the date of

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appointment of the FDIC as receiver and (Y) the date on which the cause of action accrues. b. In the case of any tort claim, the longer of (i) the period under applicable state law and (ii) the 3-year period beginning on the later of (X) the date of appointment of the FDIC as receiver and (Y) the date on which the cause of action accrues, Section 210(a)(10), except that the FDIC shall have the right to bring an action in respect of any tort claim arising from fraud, intentional misconduct resulting in unjust enrichment, or intentional misconduct resulting in substantial loss to the covered financial company for which the applicable statute of limitations under state law expired not more than 5 years prior to the FDICs appointment of receiver without regard to the expiration of the statute of limitations, Section 210(a)(10)(C). 4. Any court of competent jurisdiction may, at the FDICs request, issue an order in accordance with Rule 65 of the Federal Rules of Civil Procedure or similar state rule (except that a showing with respect to the irrevocable and immediate nature of the injury, loss or damage shall not be required), including an order placing the assets of any person designated by the FDIC under the control of the court and appointing a trustee to hold such assets, Section 210(a)(13) and (14). 5. No court may take any action to limit the exercise of powers of the receiver, and remedies against the FDIC or receiver shall be limited to money damages, Section 210(e). In addition, no suit can be brought against the FDIC, as re-

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ceiver, for a determination with respect to assets of the receivership, except as expressly provided by the Act, Section 210(a)(9)(D). J. Formality Requirements for Agreements Against Interest. An agreement that tends to diminish or defeat the interest of the [FDIC] as receiver in any asset of the covered financial company or of a bridge financial company to the extent such asset was acquired from the covered financial company will not be valid against the receiver unless such agreement: 1. is in writing; 2. was executed by an authorized officer of the covered financial company or confirmed in the ordinary course of business by the covered financial company; and 3. has been, since the time of its execution, an official record of the company or the party claiming under the agreement provides documentation, acceptable to the receiver, of such agreement and its authorized execution or confirmation by the covered financial company, Section 210(a)(6). N.B. This provision, which may be unfamiliar to bankruptcy practitioners, is derived from the FDIA, 12 USC 1823(e), and largely codifies the DOench Duhme doctrine invalidating secret side agreements. See Duhme & Co. v. FDIC, 315 U.S. 447 (1942). The Act contains a similar provision with respect to agreements against the interest of bridge financial companies, Section 210(h)(7). II. Transfer of Assets of Covered Financial Company; Mergers. The FDIC, as receiver, has the power to merge the covered financial company with another company or transfer

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any asset or liability of the covered financial company (including any such asset or liability held for security entitlement holders, customer property or any assets and liabilities associated with a trust or custody business) without obtaining any approval, assignment or consent with respect to such transfer other than certain governmental approvals, Section 201(a)(1)(G). The Act includes a number of provisions to enhance and limit this power, including the following: A. Enforceability of Restrictions on Investments in Covered Financial Companies. Any provision of any contract that directly or indirectly (a) affects or restricts the ability of any person to offer to acquire or acquire, (b) prohibits any person from offering to acquire or acquiring or (c) prohibits any person from using any previously disclosed information in connection with an offer to acquire or the acquisition of, any covered financial company (including any liabilities, assets or interest therein) in any transaction in which the FDIC exercises its authority under the Act, is unenforceable as contrary to public policy, Section 210(p). Query whether this may raise opinion issues with respect to financing agreements containing investment covenants? B. Prohibited Transferees of Assets of Covered Financial Companies. Assets of a covered financial company shall not be permitted to be sold to, among others: 1. any person who has defaulted on one or more obligations to the covered financial company, the aggregate amount of which exceeds $1 million, has been found to have engaged in fraudulent activity in connection with any such obligation, and proposes to purchase any such asset through the use of proceeds of a loan from the FDIC or from any covered financial company;

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2. any person who participated, as an officer or director of such covered financial company, in a material way in any transaction that resulted in a substantial loss to such company; or 3. any person who has demonstrated a pattern or practice of defalcation regarding obligations to such covered financial company, in each case unless such transfer resolves or is part of the resolution of claims that have been or could have been asserted by the Corporation against such person, Section 201(r). III. Bridge Financial Companies. The FDIC, as receiver or in anticipation of becoming receiver, may form one or more bridge financial companies, which may assume liabilities of a covered financial company (other than liabilities to holders of equity in respect of their equity), purchase assets of such company (including any assets relating to any trust or custody business) or perform any other temporary function, Sections 210(h)(1), 210(a)(1)(F), 210(h)(3)(B) and (C). A. Rights and Approvals. Without any approval under Federal or state law, the bridge financial company may, at the FDICs option, succeed to and assume any rights, powers, authorities or privileges of the covered financial company, Section 210(h)(2)(E)(i). In circumstances where the merger or sale of a bridge financial company would require approval of a Federal agency, the Act provides for specific processes relating to such approvals, Section 210(h)(10). B. Assumption of Liabilities; Solvency. The amount of liabilities assumed by a bridge financial company from a covered financial company may not exceed the aggregate amount of assets of the covered financial company transferred to the bridge financial company from such covered financial company, Section

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210(h)(5)(F). The FDIC is not required to inject any capital into a bridge financial company, and the bridge financial company may operate without satisfying otherwise applicable capital requirements, Section 210(h)(2)(G). The FDIC may cause the bridge financial company to issue and offer for sale stock and other securities, Section 210(h)(2)(G)(iii). C. Organization and Duration of Bridge Financial Company. A bridge financial company is federally chartered, but may elect to follow corporate governance practices and procedures applicable to a corporation organized under the laws of the State of Delaware or the state of incorporation of the covered financial company with respect to which it was established. Its existence must terminate by the earlier of (a) the two year anniversary of its formation (subject to up to three 1year extensions) and (b) the occurrence of a merger or consolidation of the bridge financial company, the sale of 80 percent or more (or, at the FDICs election, a majority) of the capital stock of the bridge financial company to a person other than the FDIC or another bridge financial company, or at the FDICs election, the assumption of all or substantially all of the liabilities of the bridge financial company by or the sale of all or substantially all the assets of the bridge financial company to a person that is not a bridge financial company, Section 210(h)(2)(F), Section 210(h)(12) and (13). N.B. The Acts relatively short duration for a bridge financial company is consistent with the absence of a conservatorship option. D. Obtaining Credit. A bridge financial company may obtain unsecured credit, and if it unable to do so, the FDIC may authorize it to issue debt: 1. with priority senior to all of its other obligations;

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2. secured by a lien on its unencumbered property; 3. secured by a junior lien on its encumbered property; or 4. after notice and a hearing before a Federal court, secured by a senior or equal lien on its encumbered property if (a) the company is unable to otherwise obtain such credit and (b) there is adequate protection of the interest of the holder of the existing lien, Section 210(h)(16). N.B. This is essentially a shortened version of Bankruptcy Code 364. Note that the granting of a priming lien is an exceptional instance in which prior court approval is required. E. Funding by FDIC. The FDIC may provide funding to facilitate the purchase of assets or assumption of liabilities by a bridge financial company from a covered financial company or to facilitate a merger or consolidation of the bridge financial company with a person that is not a bridge financial company, certain sales of capital stock of the bridge financial company to a person other than the FDIC or the sale of assets of the bridge financial company to or assumption of liabilities of the bridge financial company by a third party, Section 210(h)(9). F. Bridge Financial Companies for Broker-Dealers. If the FDIC establishes one or more bridge financial companies with respect to a covered broker or dealer, the FDIC must transfer to one such bridge financial company all customer accounts of the covered broker dealer and all associated customer name securities and customer property (which transfer shall not require the consent of any customer or court), unless the FDIC, after consulting with the Securities and Exchange Commission and SIPC, determines that the customer accounts, customer name securi-

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ties and customer property are likely to be promptly transferred to another registered broker dealer or the transfer would materially interfere with the ability of the [FDIC] to avoid or mitigate serious adverse effects on financial stability or economic conditions in the United States, Section 210(a)(1)(O). A bridge financial company for a broker or dealer is deemed registered with the SEC, is a member of SIPC and is subject to the Federal securities laws, Section 210(h)(2)(H). G. Stay of Actions. If a bridge financial company becomes party to an action by virtue of its acquisition of assets or assumption of liabilities from a covered financial company, such action shall be stayed upon the request of the bridge financial company for no longer than 45 days (or such longer period as may be agreed by the parties to such action), Section 201(h)(6). H. Taxes. A bridge financial company shall be exempt from all Federal, state and local taxation, Section 210(h)(10). IV. Qualified Financial Contracts. The Act contains close-out, anti-stay and avoidance safe harbors for qualified financial contracts4 similar to those in the Bankruptcy Code, but uses an approach modeled on the FDIA to permit the FDIC, as receiver, to preserve value by transferring valuable qualified financial contracts soon after its appointment. The Act temporarily suspends the exercise of termination, netting and similar remedies under any qualified financial contract with a covered financial company triggered by the appointment of the receiver for the covered financial company until 5 p.m. Eastern Time on the business day following the date of the appointment (such time, the QFC TransferThe Act uses this term as a collective reference for securities contracts, commodity contracts, forward contracts, repurchase agreements, swap agreements and any similar agreements that the FDIC determines by regulation, resolution or order to be a qualified financial contract, with such constituent terms being defined in the Act in a manner similar to their Bankruptcy Code definitions. The Act does not specifically include master netting agreements as qualified financial contracts.4

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Period), and renders them permanently unenforceable if such person receives notice within such period that the qualified financial contract has been transferred as described in Paragraph IV.C below), Sections 210(c)(8)(A), 210(c)(10)(B).5 The Act also creates a grace period for performance on qualified financial contracts during the QFC Transfer Period, Section 210(c)(8)(F)(ii). N.B. The Act does not excuse performance defaults by the transferee after the QFC Transfer Period. A. Walkaway Clauses Unenforceable. The Act renders unenforceable provisions in a qualified financial contract that eliminate or reduce payment obligations on the part of the counterparty because of the insolvency or receivership of a covered financial company, Section 210(c)(8)(F). B. Avoidability of Transfers in Connection with Qualified Financial Contracts. The Act provides that the FDIC, as receiver, may not avoid any transfer of assets in connection with any qualified financial contract, unless the transferee had actual intent to hinder, delay or defraud the covered financial company, the creditors of such company or the FDIC, as receiver, Section 210(c)(8)(C). C. Transfer of Qualified Financial Contracts. In the event that the FDIC transfers to a third party any qualified financial contracts between a covered financial company on one hand and a person or any of its affiliates, on the other hand, it must transfer all qualified financial contracts between such person and its affiliates and the covered financial company to one financial institution, together with all unsubordinated claims of such persons against the covered financial company pursuant to such contract, all claims of the covered financial company against such5

Note that the Bankruptcy Code, unlike the Act, allows counterparties to qualified financial contracts to exercise such rights immediately upon the filing of their counterpartys bankruptcy petition, rather than only after the QFC Transfer Period.

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persons under such contract, and all property securing any obligations of the covered financial company under such agreement, Section 210(c)(9). V. Orderly Liquidation Fund. The Act establishes the Orderly Liquidation Fund (the Fund) to finance the FDICs activities under the Act, Section 210(n)(1), and provides that all funds expended in connection with a liquidation under the Act either must be recovered from the disposition of such companys assets or shall be the responsibility of the financial sector through assessments. A. Orderly Liquidation Plan. Amounts in the Fund are available to the receiver with respect to a specific covered financial company only after the FDIC has developed an orderly liquidation plan with such company that is acceptable to the Secretary of the Treasury, Section 210(n)(9)(A). B. Source of Funds. The Fund is to be financed with the proceeds of debt obligations (the FDIC Debt Obligations) issued by the FDIC for this purpose and riskbased assessments (Assessments) by the FDIC on any financial company with consolidated assets equal to or greater than $50 billion or any nonbank financial company supervised by the Board of Governors of the Federal Reserve (any such entity an Assessable Financial Company), Sections 210(n)(2), 210(o). 1. Subject to certain limitations, the FDIC may issue obligations to the Secretary of the Treasury, the proceeds of which will be deposited in the Fund, and the Secretary of the Treasury may in turn sell such obligations to third parties, Section 210(n)(5). The amounts of such obligations issued to fund activities in respect of a covered financial company may not exceed:

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a. 10% of the total consolidated assets of the covered financial company during the 30-day period following the date of the appointment of the receiver (unless the amount described below is calculated prior to such date); or b. if an agreement is in effect between the Secretary of the Treasury and the FDIC that includes a plan and schedule for repayment of the outstanding amount of all such obligations and demonstrates that income to the FDIC from the liquidated assets of the covered financial company, and Assessments will be sufficient to repay the outstanding balance within the period described in the repayment schedule, 90% of the fair value of the total consolidated assets of the covered financial company that are available for repayment of such obligations, Section 210(n)(9)(B). 2. The FDIC must charge one or more Assessments if necessary to fully repay the FDIC Debt Obligations within 60 months of their issue date (or such longer period as is necessary to avoid a serious adverse effect on the financial system of the United States). a. The FDIC must first attempt to repay the FDIC Debt Obligations by making Assessments on any unsecured claimants to the extent such claimants received from the FDIC payments allowing the claimant to receive more than similarly situated creditors (as described in Paragraph I.G.3 above) and on any other creditors who received more than they were entitled to from liquidation proceeds in connection with the payment of claims of the covered financial company (as described in Paragraph I.F.4 above).

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b. In the event that amounts recovered from such creditors are insufficient to repay the obligations of the FDIC within the applicable time period, the FDIC must impose additional Assessments on Assessable Financial Companies to recover the remaining amounts, Section 210(o)(1). 3. The amount of Assessments on financial companies will vary based on the amount of assets of the financial company and the amount of risk posed by such company, in accordance with a risk matrix established by the FDIC, after consultation with the Financial Stability Oversight Council established by the Act, Section 210(o)(2, 4). The matrix must account for any risks presented by a financial company during the previous 10 years that contributed to the failure of the covered financial company, any risks presented by a financial company to the financial system and the likelihood that such company would benefit from an orderly liquidation of the subject covered financial company. VI. Bankruptcy Code Analogs. It is generally not possible to determine with certainty in advance whether a particular financial company will become a Bankruptcy Code debtor or a covered financial company in an Act receivership if it were to encounter severe financial distress. Consequently, parties attempting to document and structure transactions with a financial company may not know which statutory scheme would ultimately govern such transactions were the financial company to become insolvent. To reduce the inherent legal uncertainly, the Act closely harmonizes with the Bankruptcy Code a number of its key provisions dealing with prepetition/prereceivership transactions.6

The existence of disparities between the FDIA and Bankruptcy Code provisions is less problematic, because contract parties generally know in advance with certainty whether their counterparty would be subject to the FDIA in the event of a failure.

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A.

Avoidance Provisions. The Act contains avoidance language closely-modeled on the language of Bankruptcy Code 547, 548 and 549, incorporates by reference all of the defenses available to a transferee or obligee under Bankruptcy Code 547, 548 and 549, incorporates Bankruptcy Code 546(b) and (c), 547(c) and 548(c), and contains language similar to that contained in Bankruptcy Code 550 authorizing recoveries from transferees, Section 210(a)(11).

B.

Setoff. The Act allows a creditor to offset a mutual debt owed by the creditor to a covered financial company in substantially the same circumstances as a creditor may exercise such right in bankruptcy (including similar provisions limiting setoff where claims were transferred and positions improved), compare Bankruptcy Code 553 with Section 210(a)(12) of the Act. Generally, transferees (including bridge financial companies) of assets from the receiver are subject to such claims or rights as would prevail over the rights of the transferee under applicable noninsolvency law, Section 210(a)(1)(G)(iii). However, the Act provides that the FDIC may transfer any assets of the covered financial company free and clear of the setoff rights of a creditor, in which case such creditor shall be entitled to a claim junior to those described in Paragraph I.G.1.a-d but senior to all other unsecured claims against the covered financial company, Section 210(a)(12)(F).

C.

Contract Repudiation and Damages Generally. The FDIC, as receiver, may disaffirm or repudiate any contract to which the covered financial company is a party, if the FDIC determines that the performance of such contract would be bur-

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densome and that the disaffirmance or repudiation of such contract will promote the orderly liquidation of the covered financial company, Section 210(c)(1).7 1. In general, damages for repudiation are limited to actual direct compensatory damages, Section 210(c)(3), but the Act includes special provisions relating to repudiation of financial contracts (damages equal the normal and reasonable costs of cover and other damages utilized in the industry), debt obligations (damages equal the aggregate principal amount of the debt plus accrued interest and accrued original issue discount (including, in the case of fully secured claims, interest accruing to the date of repudiation8), contingent obligations (damages equal no less than the estimated value of the claim as of the date of the FDICs appointment as receiver, based on the likelihood that such contingent claim would become fixed and the probable magnitude thereof) and leases under which the covered financial company is lessee (damages equal contractual rent accruing before the later of the mailing of the notice of disaffirmance and the effectiveness of the disaffirmance), Section 210(c)(3)(7). The Act also contains protections similar to the Bankruptcy Code for

Unlike the Bankruptcy Code 365, the Act permits repudiation of any contracts, rather than just executory contracts. 8 Note the difference between the payment of postpetition interest on oversecured claims provided for in the Bankruptcy Code (where such interest runs to the date of repayment) and the postreceivership interest on oversecured claims permitted by the Act (which runs only to the date of repudiation). In circumstances where the FDIC repudiates an agreement relating to oversecured debt of the covered financial company soon after its appointment as receiver, the permitted post-receivership interest may amount to very little as compared to the postpetition interest that will accrue, but will not be paid, up to the date of repayment.

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such contract providing for termination, default or acceleration upon or solely by reason of insolvency, the appointment of or exercise of rights by the receiver or any actions or events occurring in connection therewith, Section 210(c)(13)(A). 1. With certain limited exceptions relating to qualified financial contracts and certain other types of agreements, for 90 days after the FDIC is appointed as receiver, no person may exercise any right to terminate, accelerate or declare a default under any contract (including contracts to extend credit to the covered financial company) with the covered financial company or to affect any contractual rights of the covered financial company, in each case, without the consent of the FDIC, as receiver, Section 210(c)(13)(C). 2. In the event that the FDIC enforces any contract to extend credit to a covered financial company or bridge financial company, the FDIC shall repay such debt as an administrative expense of the receivership, Section 210(c)(13)(D). 3. The FDIC may also enforce contracts of subsidiaries or affiliates of the covered financial company if the obligations under such contracts are guaranteed by or otherwise linked to the covered financial company, notwithstanding any contractual right to cause the termination of such contracts based solely on the insolvency, financial condition, or receivership of the covered financial company, provided that (a) such guaranty and all related assets and liabilities are transferred to and assumed by a bridge financial company or a third party by 5 p.m. Eastern Time on the business day following the appointment of the receiver or (b) the FDIC otherwise provides adequate protection with respect to such obligations, Section 210(c)(16).

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E. Stockbroker and Commodity Broker Liquidations. The terms of chapters III and IV of chapter 7 of the Bankruptcy Code will govern the distribution of customer name securities and customer property in connection with a liquidation of a covered financial company or bridge financial company that is or has a subsidiary that is a stockbroker but is not a member of the Securities Investor Protection Corporation, and the distribution of customer property in connection with the liquidation of any covered financial company or bridge financial company that is a commodity broker, respectively, in each case, as if such entity were a bankruptcy debtor, Section 210(m)(1)(A) and (B). VII. Treatment of Executives and Directors. A. Prohibition of Participation in Financial Company Affairs. The Board of Governors of the Federal Reserve (in the case of a covered financial company supervised by it) or the FDIC (with respect to any other covered financial company) may prohibit any senior executive or director of a covered financial company from participating in the conduct of affairs of any qualified financial company for a period of not more than 2 years if such agency finds that: 1. Such person (i) directly or indirectly violated a law, regulation or order or any written agreement with such agency, engaged in any unsafe or unsound practice in connection with any financial company or committed a breach of fiduciary duty and (ii) has received financial gain or other benefit by reason of such activity; and

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2.

Such activity involves personal dishonesty or demonstrates willful or continuing disregard for the safety or soundness of such company, Section 213.

B.

Recoupment of Compensation. The FDIC, as receiver of a covered financial company, may recover from any current or former senior executive or director substantially responsible for the failed condition of the company any compensation received during the 2-year period preceding the appointment of the receiver, Section 210(s).

C.

Money Damages. The directors and officers of a covered financial company may be held personally liable for money damages in any action brought by or at the direction of the FDIC for gross negligence or conduct that demonstrates a greater disregard of a duty of care than gross negligence (including intentional tortious conduct), Section 210(f).

VIII. Other Provisions. A. No Bail-Outs. 1. The act prohibits funding for the orderly liquidation of any covered financial company except as provided in the Act, Section 212(a). 2. No governmental entity may take any action to circumvent the purposes of this title. Section 212(b) 3. All financial companies put into receivership under this title shall be liquidated. No taxpayer funds shall be used to prevent the liquidation of any financial company under this title. Section 214(a)

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4. Taxpayers shall bear no losses from the exercise of any authority under this title. Section 214(c) B. Studies Authorized. The Act mandates the conduct of: 1. A study aimed at determining, among other things, whether a secured creditor haircut could improve market discipline and protect taxpayers, Section 215. 2. A study aimed at assessing the effectiveness of the Bankruptcy Code in facilitating the orderly liquidation or reorganization of systemic financial companies, including whether a special court, panel or masters should be used and whether amendments should be adopted, Section 216. 3. A study on international coordination relating to the resolution of systemic financial companies, Section 217.

ABI/NYU BANKRUPTCY AND BUSINESS REORGANIZATION WORKSHOP ADVANCED PROGRAM

Basic Features of the Dodd-Frank Wall Street Reform and Consumer Protection Act1Financial Stability: Systemic Risk Regulation 1. Creation of Financial Stability Oversight Council a. 15-member council acts to serve as an early warning system by identifying risks in firms and market activities. 2. Enhanced Prudential Standards for Systemically Important Firms a. Systemically important nonbank financial companies to be so designated based on certain characteristics. If designated, enhanced prudential standards (described below) apply. b. Bank holding companies with $50 billion or more in assets are automatically subject to enhanced prudential standards. c. Enhanced prudential and other standards to apply to systemically important firms (including enhanced risked-based capital, leverage and liquidity requirements, overall risk management requirements, resolution plans, credit exposure reporting, concentration limits and prompt corrective action) to be established by the Federal Reserve in consultation with the Financial Stability Oversight Council. d. Generally, rules implementing these requirements must be issued within 18 months after enactment. 3. Remediation of Financial Distress a. Federal Reserve, in consultation with the Financial Stability Oversight Council and the FDIC, to establish requirements for early remediation of financial distress. i. Upon a finding by the Federal Reserve, with the approval of a two-thirds vote of the Financial Stability Oversight Council, that a systemically important company presents a grave threat to financial stability in the United States, the Federal Reserve must take actions to mitigate such risk, including limiting the companys ability to merge with, acquire or otherwise become affiliated with another company, restricting the ability of the company to offer financial or other products, or ordering termination of activities. 4. Heightened Prudential Standards for Certain Financial Activities a. The Financial Stability Oversight Council may recommend heightened prudential standards or safeguards for particular financial activities or practices conducted by any company subject to regulation by a primary financial regulatory agency (including insurance companies), if it finds that the conduct, scope, nature, size, scale or interconnectedness of the activity or practice could create or increase the1

This outline does not address Title XIV of the Act Mortgage Reform and Anti-Predatory Lending Act.

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risk of significant liquidity, credit or other problems spreading among bank holding companies and nonbank financial companies or the U.S. financial markets. 5. Broad Authority Granted to Federal Reserve a. Includes enhanced registration and reporting requirements. 6. Treatment of Foreign Financial Companies a. Foreign banks that operate a branch, agency or commercial lending subsidiary in the United States are treated as though they were bank holding companies. As a result, they are covered by the systemic risk provisions of the Act. b. Foreign nonbank financial companies may be designated as systemically important by the Financial Stability Oversight Council if predominantly engaged in financial activities. 7. The Office of Financial Research (OFR) a. New, self-funded, largely independent office with the power to gather vast amounts of information from financial market participants and to require standardization of financial information to be reported to the OFR and other regulators. Orderly Liquidation Authority (OLA) 1. OLA replaces the Bankruptcy Code and other applicable insolvency laws for liquidating financial companies and certain of their subsidiaries under certain circumstances. a. OLA could apply to any financial company if certain determinations, focusing primarily on the perceived risk a company poses to financial stability in the United States and the costs and benefits of alternative actions, are made. b. Process for designating covered financial companies (as defined by the Act) typically includes a determination by the Treasury Secretary, upon recommendation by two-thirds of the Federal Reserve Board and two-thirds of the FDIC Board, and consultation with the President. c. Limited judicial review of any such designation is expedited and confidential. 2. Upon the appointment of FDIC as receiver, except in the case of covered broker-dealers or covered insurance companies, the FDIC will apply the provisions of the OLA instead of the Bankruptcy Code or other applicable insolvency law. 3. OLA Rules: a. FDIC succeeds by operation of law to all rights, titles and powers of the company and its stakeholders. b. FDICs powers are modeled largely on its powers under the Federal Depository Insurance Act (FDIA) and include cherry-picking powers and the ability to transfer assets to a third party.22

A key tool in the FDICs core resolution powers is the ability to cherry-pick the assets or liabilities of a covered financial company and transfer only selected assets and liabilities to a third party or bridge financial company without the need to obtainContinued

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i. The FDICs core resolution powers authorize it to transfer all or any portion of the assets or liabilities of the financial company to a third party at fair value. If a third-party buyer cannot be found at fair value, the FDIC would have the authority to establish a temporary bridge financial company to hold any part of the business worth preserving until it could be sold to a third party at fair value or otherwise liquidated in an orderly fashion. c. Priority of claims among unsecured creditors ensures that amounts owed to the United States receive priority and that senior executives, directors and equity holders are last to be paid. d. In connection with exercising its resolution powers, the FDIC may differentiate between creditors within the same class or treat junior creditors better than senior creditors under certain circumstances, so long as any disadvantaged creditor receives at least as much as it would have received in a liquidation under Chapter 7 of the Bankruptcy Code or otherwise applicable insolvency laws. e. Three-year time limit on receivership, with possibility of two one-year extensions. f. Includes provisions designed to provide customers of covered broker-dealers with certain protections typically found in a SIPA liquidation proceeding.3 g. Prohibition on the enforceability of ipso facto clauses does not apply to Qualified Financial Contracts (QFCs), subject to a one-business-day stay period during which the FDIC has the option to transfer all (but not less than all) QFCs with a particular counterparty and its affiliates to a single third-party financial institution. i. If the FDIC exercises this option, the counterparty may not terminate, accelerate or otherwise exercise its rights to close out any such QFCs solely by virtue of the FDICs appointment as receiver, the insolvency of the financial company or the transfer of any such QFCs to a third party. 4. Orderly liquidation fund established within the Treasury from which the FDIC may borrow funds to carry out its mission under the OLA. 5. Includes additional provisions to address coordination with foreign financial authorities, choice of law rules, guaranteed subsidiary contracts, clearing organizations and liability and compensation for officers and directors, in addition to requiring a study on secured credit haircuts and prohibiting taxpayer funding of bailouts. 6. Inspector General of the FDIC, Treasury Inspector General and the Inspectors General of the primary financial regulatory agencies are entitled to supervise, audit and investigate the liquidation of a covered financial institution.any creditors consent or prior court review. Other assets and liabilities can be left behind to be liquidated, potentially creating differential treatment for otherwise similarly situated creditors, as discussed below. 3 If the FDIC is appointed as receiver of a covered broker-dealer, the FDIC will have the core resolution powers to establish one or more bridge financial companies and to transfer all or any portion of the covered broker-dealers assets and liabilities, including customer accounts and related customer name securities and customer property to the bridge financial company. At the same time, the FDIC is required to appoint SIPC as trustee to liquidate the covered broker-dealer and any of its assets or liabilities, including customer accounts and related customer name securities and customer property that are left behind, in a liquidation proceeding under SIPA, except as otherwise provided by the OLA.

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7. The FDIC must report to Congress regarding the liquidation. The Volcker Rule 1. Prohibits proprietary trading by any banking entity, subject to certain exceptions and a transition period. a. Certain types of transactions (including purchases and sales of U.S. government or agency obligations, certain risk-mitigating hedging activities and purchases and sales of securities or other instruments on behalf of customers) are permitted activities and are excluded from the general ban; however, limitations are placed on some transactions that would otherwise be permitted, including prohibition under certain circumstances. 2. Prohibits any banking entity from acquiring or retaining any equity, partnership or other ownership interest in, or sponsoring, any hedge fund or private equity fund (with certain exceptions). a. Subject to the same limitations on permitted activities applicable to proprietary trading as well as any additional restrictions or limitations that certain regulators may impose. Certain additional activities are excluded from the ban on sponsoring or investing in hedge funds or private equity funds. 3. Explicitly provides for no prohibition on certain securitization activities, but the Acts credit retention provisions separately require the federal banking agencies and the SEC to prescribe additional regulations for securitizers. 4. Additional Limitations: a. If regulators determine that additional capital requirements or quantitative limits, including diversification requirements, would be appropriate to protect the safety and soundness of any banking entities engaged in permitted proprietary trading or permitted sponsoring or investing in hedge funds or private equity funds, the regulators are required to impose such additional capital requirements and quantitative limits. b. Limitations on covered transactions (as defined by Section 23A of the Federal Reserve Act) with advised or managed funds.4 Certain exceptions exist for prime brokerage transactions with hedge funds or private equity funds. c. Compliance with Section 23B of the Federal Reserve Act required in certain circumstances.54

Section 23A(b)(7) of the Federal Reserve Act defines covered transactions with respect to an affiliate of a member bank as: A. a loan or extension of credit to the affiliate; B. a purchase of or an investment in securities issued by the affiliate; C. a purchase of assets, including assets subject to an agreement to repurchase, from the affiliate, except such purchase of real and personal property as may be specifically exempted by the Board by order or regulation; D. the acceptance of securities issued by the affiliate as collateral security for a loan or extension of credit to any person or company; or E. the issuance of a guarantee, acceptance or letter of credit, including an endorsement or standby letter of credit, on behalf of an affiliate. 5 Section 23B of the Federal Reserve Act places restrictions on transactions with affiliates.

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d. Appropriate federal regulators must issue rules regarding internal controls and recordkeeping to ensure compliance with the Volcker Rule. Such regulators must order termination of activities or disposal of investments resulting from actions that serve to evade the requirements of the Volcker Rule. 5. Applicability to Nonbank Financial Companies a. Although systemically important nonbank financial companies are not subject to the prohibitions on proprietary trading or sponsoring or investing in hedge funds or private equity funds, the Federal Reserve is required to impose additional capital requirements and other quantitative limits on such activities. Similarly, regulators are required to adopt rules imposing additional capital charges or other restrictions to address the same types of risks and conflicts of interest addressed by the Section 23A and Section 23B limits on such activities (which otherwise would not apply to nonbank financial companies). 6. Effective Date a. Not effective until the earlier of 12 months after the issuance of final rules implementing the Volcker Rule and two years after enactment of the Volcker Rule. b. Within two years after the effective date of the Volcker Rule, banking entities and systemically important financial companies must conform their activities and investments to be in compliance. 7. Implementation: Study, Recommendations and Rulemaking a. Financial Stability Oversight Council to conduct a study and issue recommendations on implementation of the Volcker Rules provisions within six months of enactment. b. Appropriate federal regulators (including the appropriate federal banking agencies, the Commodities and Futures Trading Commission (CFTC) and the SEC) are required to issue rules implementing the Volcker Rule within nine months of the completion of such study, as well as transition rules within six months of the Volcker Rules enactment. Swaps Pushout Rule 1. Prohibits certain types of federal assistance to certain swap dealers and major swap participants. a. Precludes the use of taxpayer funds to prevent the receivership of any swaps entity resulting from that entitys swaps activity if the entity is FDIC-insured or has been designated as systemically important. 2. Insured depository institutions are exempt from the prohibition on federal assistance if they limit their swaps activities in specified ways. a. Insured depository institutions may have a swaps entity affiliate and still receive federal assistance under certain circumstances.

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3. Explicitly provides that insured depository institutions are subject to the Volcker Rule with respect to their proprietary activity in derivatives, including swaps. 4. Effective Date a. Swaps Pushout Rule to become effective two years after the derivatives title of the Act becomes effective (360 days after enactment). A transition period is provided for swaps entities that are insured depository institutions. Bank Capital (Collins Amendment) 1. Minimum leverage and risk-based capital requirements to be established by the appropriate federal banking agencies. Among other things, requires that the appropriate federal banking agencies impose capital requirements on insured depository institutions, depository institution holding companies and systemically important nonbank financial companies to address the risks to other public and private stakeholders arising out of certain activities. 2. Implementing regulations must be issued no later than 18 months following the Acts effective date. 3. General rule for bank holding companies and systemically important nonbank financial companies: any regulatory capital deductions for debt or equity issued before May 19, 2010 will be phased in incrementally from January 1, 2013 to January 1, 2016, with certain exceptions. a. Various heavily negotiated transition periods and permanent (grandfathered) exemptions. 4. Mandated Studies of Capital Requirements a. Government Accountability Office (GAO), in consultation with the federal banking agencies, to conduct three studies and submit reports to Congress within 18 months of enactment. Such studies to focus on issues related to (i) holding company capital requirements, (ii) foreign bank intermediate holding company capital requirements and (iii) small banks. Derivatives 1. Generally grants the CFTC jurisdiction over swaps and swaps market participants, and grants the SEC jurisdiction over security-based swaps and security-based swaps market participants. The two commissions share jurisdictions over mixed swaps. 2. New and amended definitions include: a. New categories of market participants (swap dealer6 and major swap participant7).6

swap dealer any person that holds itself out as a dealer in swaps; makes a market in swaps; regularly enters into swaps as an ordinary course of business for its own account; or engages in any activity causing the person to be commonly known in the trade as a dealer or market-maker in swaps. The definition excludes a person that enters into swaps for such persons own account, individually or in a fiduciary capacity, but not as part of a regular business.

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b. Revisions to existing definitions of certain market participants (futures commission merchant, introducing broker, commodity pool and commodity pool operator). 3. Clearing, Trading and Reporting of Swaps a. Requires the clearing of certain swaps as determined by the CFTC or SEC (with exemptions). b. Requires that all swaps that are subject to the clearing requirement be traded on a board of trade designated as a contract market or securities exchange or through a swap execution facility, unless no such entity accepts the swaps for trading. c. CFTC and SEC must promulgate rules for real-time public data reporting of swap transactions, including price and volume. 4. Other New Requirements Concerning Swaps a. CFTC and SEC to adopt business conduct standards for swap dealers and major swap participants. b. Capital and margin requirements to be imposed. c. Protections provided for counterparty funds and property. d. Position limits to be established by the CFTC and/or SEC. Reporting requirements to be imposed. 5. Extraterritoriality of certain provisions explained in greater detail. 6. Exchange Act beneficial ownership reporting requirements amended to address securities-based swaps. 7. Rulemaking and Effective Date a. CFTC and SEC to promulgate required rules within 360 days of enactment, including rules to mitigate conflicts of interest. b. Effective date is the earlier of 360 days after enactment or, to the extent a provision requires rulemaking, no less than 60 days after publication of a final rule or regulation implementing such provision. 8. Enhanced enforcement authority granted to certain regulators and prohibitions on insider trading and disruptive practices imposed. 9. Awards provided for whistleblowers. 10. Swaps will not be subject to Section 1256 of the Internal Revenue Code for the years following the date of enactment. 11. CFTC regulation of contract markets and clearinghouses amended.7 major swap participant any non-dealer: (i) that maintains a substantial position in swaps for any of the major swap categories as determined by the CFTC and SEC (with certain exclusions); (ii) whose outstanding swaps create substantial counterparty exposure that could have serious adverse effects on the financial stability of the United States banking system or financial markets; or (iii) that is a financial entity that maintains a substantial position in outstanding swaps in any major swap category as determined by the CFTC and SEC, is highly leveraged relative to the amount of capital it holds and is not subject to capital requirements established by an appropriate federal banking agency.

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12. Rules and regulations regarding foreign boards of trade. 13. Amendments to the Exchange Act and Commodity Exchange Act to facilitate portfolio margining under certain circumstances. Regulation of Advisers to Hedge Funds and Others 1. SEC registration required for broad range of advisers due to elimination of the private investment adviser exemption contained in Section 203(b)(3) of the Investment Advisers Act as well as the intrastate registration exemption for investment advisers with any private fund client. 2. New recordkeeping and reporting obligations imposed. 3. Other provisions include rules of construction relating to the Commodity Exchange Act, provisions addressing custody of client assets, adjustments for inflation to the accredited investor and qualified client standards, etc. 4. Unless otherwise specified, provisions become effective one year after enactment. 5. GAO and SEC to conduct various studies related to the feasibility of forming a selfregulatory organization to oversee private funds, short sales, accredited investor status and custody rule costs. Investor Protection and Improvements to the Regulation of Securities 1. Assortment of provisions intended to improve investor protection and strengthen brokerdealer regulation. 2. Provisions Relating to Fiduciary Duties of Broker-Dealers and Investment Advisors a. SEC is required to undertake a study and provided discretionary authority to impose a new fiduciary duty rule on broker-dealers and investment advisers. 3. Provisions Relating to Securities Law Enforcement a. Three general categories of enforcement-related provisions: i. expansion of the scope of the securities laws to permit certain enforcement proceedings and actions; ii. elimination of a number of procedural barriers and provision of the SEC with additional enforcement tools; and iii. changes to the way the SEC carries out its internal functions. b. SEC to issue rules (i) disqualifying anyone convicted of a felony or misdemeanor in connection with the purchase or sale of any security or in connection with a false filing with the SEC and other bad actors from offering or selling securities as Regulation D offerings and (ii) clarifying that Section 205 of the Investment Advisers Act does not apply to state-registered advisers. 4. Provisions Relating to Credit Rating Agencies a. Generally increases required internal controls, requires greater transparency of rating procedures and methodologies, provides investors with a private right of

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action, and provides the SEC with greater enforcement and examination tools regarding Nationally Recognized Statistical Rating Organizations (NRSROs). b. Governance and compliance requirements imposed on NRSROs. c. Penalties and liabilities imposed for certain actions. d. Private right of action: enforcement and penalty provisions of the Exchange Act to apply to statements made by credit rating agencies in the same way they apply to public accounting firms. e. Rules and requirements (including reporting requirements) imposed regarding management of conflicts of interest by NRSROs. f. Each NRSRO must establish, maintain, enforce and document an internal control structure to govern implementation of and adherence to policies, procedures and methodologies for determining ratings. g. Numerous provisions regarding procedures and methodologies used by NRSROs; SEC to issue rules. h. Additional disclosure requirements imposed, including removal of current exemption in Reg FD for credit rating agencies.8 i. Use of ratings in statutes and regulations; removal or modification required. j. Establishment of SEC Office of Credit Ratings with the power to (i) establish fines and other penalties for violations by NRSROs, (ii) administer SEC rules with respect to NRSRO ratings determination practices and (iii) conduct an annual examinations of each NRSRO. k. Studies to be conducted and reports issued by the SEC and GAO. 5. Provisions Relating to Securitizations a. Credit retention requirements to be imposed i. Regulations to be prescribed requiring securitizers of asset-backed securities, by default, to maintain 5% of the credit risk in assets transferred, sold or conveyed through the issuance of asset-backed securities. b. Prohibitions on conflicts of interest relating to certain securitizations imposed. c. Heightened reporting and disclosure requirements i. Issuers of asset-backed securities to be required to perform a review of the assets underlying an asset-backed security and to disclose the nature of the review. 6. Provisions Relating to Municipal Securities a. Requires registration and oversight of municipal advisers that solicit or provide advice to issuers of municipal securities or obligated persons with respect to the issuance of municipal securities, investment of proceeds of municipal offerings or derivatives on municipal securities.8

Reg FD currently exempts disclosures to an entity whose primary business is the issuance of credit ratings, provided that the information is disclosed solely for the purpose of developing a credit rating and the entitys ratings are publicly available.

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b. Municipal Securities Rulemaking Board provided with expanded rulemaking authority. Certain governance requirements imposed. c. GAO to perform various studies to be concluded within six to twenty-four months after enactment of the Act. Various reports to be issued. 7. Provisions Relating to Executive Compensation and Corporate Governance a. Includes provisions relating to compensation arrangements at financial institutions and public companies, including requirements of independent compensation committees and mandatory nonbinding say-on-pay votes. b. Regarding corporate governance at financial institutions and public companies, requires establishment of risk committees and additional disclosure regarding organizational structure. c. Clarifies SEC authority to adopt proxy access. 8. Provisions Relating to SEC Management and Funding a. Changes to SEC management, including various new reporting requirements. b. Increases SECs funding, but maintains the role of the Appropriations Committee in setting the SEC annual budget. 9. Amendments to Sarbanes-Oxley a. Provides for certain amendments and extensions of authority, while exempting certain small issuers from complying with Section 404(b). Elimination of the Office of Thrift Supervision (OTS) 1. Abolishes OTS, but maintains the federal thrift charter. a. Eliminates the most important advantages of the thrift charter and imposes new penalties for failure to comply with the qualified thrift lender test. b. Reallocates powers among the Federal Reserve, Office of the Comptroller of the Currency and FDIC. 2. Certain other institutional changes applicable to various agencies. Deposit Insurance Reforms 1. Determination of deposit insurance assessments a. The FDIC must base deposit insurance assessments on an insured depository institutions average consolidated total assets minus its average tangible equity, rather than on its deposit base, although the FDIC may reduce the assessment base for custodial banks and bankers banks. 2. Minimum designated reserve ratio increased to 1.35% (raised from 1.15%) of insured deposits or the comparable percentage of the assessment base. Additional changes apply. 3. The maximum deposit insurance amount is permanently increased to $250,000. 4. Transaction account insurance to be provided, with certain limitations.

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5. FDIC to conduct a study on the definition of core deposits and brokered deposits and report to Congress within one year of enactment. Amendments to Regulation of Bank and Thrift Holding Companies and Depository Institutions 1. Study to be conducted by GAO on whether to eliminate certain exemptions from the definition of bank under the Bank Holding Act. 2. Effective immediately, FDIC may not approve any application for deposit insurance received after November 23, 2009, for an industrial bank, credit card bank or trust bank, directly or indirectly, owned or controlled by a commercial firm. 3. Provisions related to regulation of bank and thrift holding companies. 4. Provisions related to regulation of banks and thrifts. 5. Expansion of current laws regarding transactions with affiliates. 6. Strengthening of provisions related to transactions with insiders (including loans or asset sales). 7. Inclusion of derivatives in lending limits. 8. New supervision program replaces elective investment bank holding company program for securities holding companies. a. The Act permits a securities holding company that is required by a foreign regulator to be subject to consolidated supervision to register with the Federal Reserve to become a supervised securities holding company. b. The Act requires the Federal Reserve to prescribe capital adequacy and other standards for supervised securities holding companies and subjects these companies to the Bank Holding Company Act and the FDIA. Payment, Clearing and Settlement 1. Designation and oversight of financial market utilities and payment clearing and settlement activities. 2. Reporting requirements and other procedural matters addressed. Bureau of Consumer Financial Protection 1. New executive agency that will assume most of the consumer protection functions exercised by regulators under certain existing federal consumer protection laws and will also enjoy independent authority under the Act with respect to covered persons (as defined in the Act). 2. The Bureau of Consumer Financial Protection is authorized to administer, enforce and otherwise implement the provisions of the Federal consumer financial law (as defined in the Act). 3. State consumer financial laws are preempted under certain circumstances.

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4. Other notable provisions include: a. restrictions on card networks and card issuers; b. authority to restrict mandatory pre-dispute arbitration; c. consumer information requests; d. expanded application of Truth in Lending Act; and e. criminal and civil penalties. 5. Includes provisions related to improving access to mainstream financial institutions, particularly with respect to small loans. Emergency Stabilization and Federal Reserve Governance 1. Modifications to Section 13(3) emergency secured liquidity powers include limiting Section 13(3) assistance to a program or facility with broad-based eligibility rather than any single or specific individual, partnership or corporation that is not part of such a broad-based program.9 2. Emergency financial stabilization provisions limit the FDICs authority to provide assistance to a bank upon a systemic risk finding to only those institutions placed into receivership. 3. Changes to the governance procedures for the Federal Reserve. Pay It Back Act 1. Institutes changes (including reductions) to TARP authorization and specifies that proceeds from the sale of Fannie, Freddie and Federal Home Loan Bank debt purchased under Treasurys emergency authority and unused funds under the America Recovery and Reinvestment Act of 2009 must be used solely for deficit reduction. Insurance 1. Federal Insurance Office established within the Treasury to monitor the insurance industry, among other things. 2. Nonadmitted insurance provisions limit state regulatory authority with respect to nonadmitted insurance strictly to the home state of the insured, with certain exceptions. 3. Prohibits a state from denying credit for reinsurance if the state of domicile of the ceding insurer recognizes such credit. Also reserves the sole responsibility for regulating a reinsurers financial solvency to its home state of domicile.

Section 13(3) currently allows the Board of Governors of the Federal Reserve System to authorize any Federal Reserve Bank, in unusual or exigent circumstances, to discount for any individual, partnership or corporation, notes, drafts and bills of exchange if such notes, drafts and bills of exchange are endorsed or otherwise secured to the satisfaction of the Federal Reserve Bank.

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D odd-Frank for Bankruptcy Lawyers Douglas G. Baird and Edward R. Morrison The recently enacted financial reform legislation empowers the Secretary of the Treasury to appoint the FDIC as receiver for troubled financial companies when their failure poses a systemic risk. Previously, the resolution process for these companies was left to the bankruptcy process. By common account, the new law reflects a repudiation of traditional bankruptcy law when it comes to the collapse of giant corporations that threaten the economy as a whole.1 Instead we have a mechanism that brings the regime used to liquidate failed commercial banks to a broader range of institutions. Perhaps the only consolation for partisans of traditional bankruptcy law is a mandate for future studies assessing the effectiveness of chapter 7 and chapter 11 in facilitating the orderly resolution or reorganization of systemic financial institutions.2 But this view is mistaken. Far from reflecting a rejection of bankruptcy principles, quite the opposite is true. First, the legislation removes bankruptcy court jurisdiction from only a narrow range of casesfinancial companies whose failure is sufficiently threatening to market stability. The vast majority of giant businesses, including systemically important ones (i.e., the General Motors of the next great recession), are not financial companies within the meaning of Title II and remain squarely in the province of bankruptcy law. Moreover, the mechanics of the new receivership process incorporate basic bankruptcy principles. They permit reorganization as well as liquidation, debtor-in-possession financing, asset sales free and clear of existing liens, claw-back of prepetition fraudulent and preferential transfers, and safe harbors for financial contracts. Nevertheless, aspects of the receivership process will at first seem alien to bankruptcy lawyers. The necessity for government intervention and the adaptation of a mechanism used for failed banks introduces new terminology and, more importantly, a new decision Harry A. Bigelow Distinguished Service Professor of Law, The University of Chicago Law School. We thank Gillian Metzger, Tom Merrill, Henry Monaghan, and Adam Samaha for their help. Harvey R. Miller Professor of Law & Economics, Columbia Law School. 1 See, e.g., Kenneth Ayotte and David Skeel, Bankruptcy or Bailouts? 35 J. Corp. L. 469 (2010); Edward R. Morrison, Is the Bankruptcy Code an Adequate Mechanism for Resolving the Distress of Systemically Important Institutions?, 82 Temp. L. Rev. 449 (2009). 2 See 216(a)(2)(A).

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maker. While traditional bankruptcy law reflects a balance of power in which the debtor in possession (DIP), the creditors committee, the DIP lender, and the bankruptcy judge play discrete roles, this regime concentrates power in a single entity, the FDIC. The almost complete absence of a judge is especially striking. In the rare cases in which it is invoked, Title II replaces the bankruptcy judge with the FDIC. The FDICs powers in this new domain largely track its longstanding powers with respect to commercial banks under the Federal Deposit Insurance Act (FDIA). As receiver, the FDIC is vested with all rights, titles, powers, and privileges of the covered financial company and may operate the covered financial company with all the powers of the members or shareholder, the directors, and the officers.3 It also has the power to make postpetition loans.4 Although Title II emphasizes that the purpose of this title [is] to provide the necessary authority to liquidate failing financial companies,5 the concept of liquidation here is a very broad one. It encompasses not just piecemeal liquidation. The FDICs powers include the right to sell substantially all of the institutions assets to another company, without obtaining any approval, assignment, or consent with respect to such transfer, unless the sale raises antitrust or related concerns.6 The FDICs powers also include (implicitly) the ability to reorganize the failing institution by transferring selected assets and claims to a bridge financial company that is owned, controlled, and potentially capitalized by the FDIC.7 The FDIC can run this bridge company for up to five years,8 with a view to merging it with another institution or selling a majority of its equity to private investors.9 Of course, the bridge may be short on cash. If it is, the FDIC can authorize the equivalent of DIP financing on terms virtually identical to those permitted by 364.10 The rights of secured creditors are generally left unaffected. While the bridge can obtain a priming lien, the FDIC must go to court and show it is providing210(a)(1)(A)(i), 210(a)(1)(B)(i). In exercising these rights, the FDIC is authorized to continue employing existing directors and managers, 210(a)(1)(C), as long as those directors and managers are not responsible for the failed condition of the covered financial company. 206(4), (5). 4 204(d). 5 204(a). 6 210(a)(1)(G). 7 210(h)(5)(A), 210(h)(2)(G). 8 210(h)(12). 9 210(h)(13). 10 210(h)(16).3

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adequate protection.11 Taken together, these powers give the FDIC the ability to implement rough approximations of 363 sales and Chapter 11 reorganizations. This concentration of power in the hands of one agency, the FDIC, is a marked departure from prevailing bankruptcy law. So is the new laws approach to financial contracts. A key driver of the new regime was the need for a better mechanism to handle these contracts. Ironically, the need for a new law came not so much from their treatment in bankruptcy, but rather from their exclusion from the bankruptcy process altogether. Financial contracts were placed outside the reach of the automatic stay and other key bankruptcy laws for several reasons. One of the most important is that providing debtors with a long window in which to make the assume-or-reject decision creates an opportunity for cherry-picking that ordinary executory contracts do not. Excluding these contracts, however, requires a distressed company to forfeit the bulk of its financial contracts when it reorganizes. While this might not be a problem for an ordinary company, such a categorical rule effectively forces the liquidation of financial companies. The experience of Lehman Brothers suggests that such liquidations are costly, at least for a company that is systemically important. The new regime modifies this rule, giving the FDIC a short window (up to two business days) to subject financial contracts to an automatic stay and transfer them to a solvent counterparty. At the end of that window, the usual rules apply and parties to these financial contracts are free to exercise their contractual rights. The heart of this new regime, in short, reflects not so much a repudiation of bankruptcy principles, but rather finding a treatment for financial contracts that charts a middle course between the Codes treatment for ordinary conventional contracts and for financial contracts. Subjecting them to an automatic stay is costly, but so too is insulating them from the process altogether. In this paper we examine the general structure of this new regime from the perspective of the bankruptcy lawyer. We first examine the part of Title II that is most foreign to the bankruptcy lawyer, the mechanism it puts in place for determining eligibility and for commencing the receivership. In the next part, we recap briefly the substantive provisions of the law itself. We highlight some of the unsettled questions and potential areas of uncertainty, but for the most part it is quite familiar ground. It is commonly said that the law reflects a decision to embrace the regime for failed banks and turns its back on Chapter 11, but the end place may not be that different from11

210(h)(16)(C)(ii).

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where we would have been if a new chapter of the Bankruptcy Code had been crafted to deal with the problem of systemically important financial companies. In the final part of the paper, we focus in particular on features of the law that may blunt its effectiveness. I. Commencing the Title II Receivership

Much of the mystery associated with the new receivership regime lies at the start of the process. There is a complicated mechanism for identifying an eligible entity, and then a rather exotic avenue of judicial review. That the trigger for this new kind of receivership is new should come as no surprise. It arises from the need to protect the legitimate interests of investors while at the same time ensuring that decisive action can be taken when unanticipated systemic risks suddenly manifest themselves.

A. Eligible Entities Title II, like the rest of Dodd-Frank, is squarely focused on Wall Street. A company is eligible only if at least eighty-five percent of its consolidated revenues arise from activities that are financial in nature.12 The eighty-five percent threshold precludes large industrial giants (the GMs of the world), no matter how systemically important they may be. It also prevents companies like Enron from entering Title II. Much of Enrons business was focused on trading activity that would fall within the definition of a financial activity, but it also owned enough hard assets, such as pipelines and power plants, to remove it from the ambit of the statute. It is easy to name companies excluded from Title II, but harder to say which are included. Title I provides for a Financial Stability Oversight Council that identifies nonbank financial companies that are systemically important. These companies will be subject to regulation and those involved with these companies will know that they are potentially exposed to Title II. The triggering mechanism in Title II, however, is largely independent of Title I. A financial company can be eligible for receivership under Title II even if it was never before thought systemically important for purposes of Title I. This reflects the intuition that, while comparatively few companies whose activities are financial in nature are systemically important, they cannot always be identified in advance. In the abstract, the eligibility standards are relatively straightforward. Only a financial company, broker or dealer, or insurance company is potentially subject to receivership. Financial company12

201(a)(11)(iii), (iv); 201(b).

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is a defined term. It includes bank holding companies, and nonbank companies supervised by the Federal Reserve, but it also includes any company predominantly engaged in activities that are financial in nature. Activities that are financial in nature are those the Federal Reserve Board identifies pursuant to a section of the Bank Holding Company Act, which limits the activities in which a bank holding company can engage beyond owning a bank.13 The identified activities can evolve over time, but the statute provides a set of activities that are explicitly financial in nature. These include providing financial, investment, or economic advisory services and insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker. Most importantly, financial activities include lending, exchanging, transferring, investing for others, or safeguarding money or securities.14 This last provision has the effect of making hedge funds and private equity funds potentially subject to Title II. Thus, while commercial banks are subject to FDIC oversight when they are healthy and when they are distressed, many financial companies are, in theory, exposed to the risk of seizure without having any previous interactions with the FDIC, or even knowing that they might be subject to it. Not only is there the potential surprise, but, again in contrast to an ordinary bank, the financial company may find itself in the hands of a regulator who knows nothing about it and lacks both the information and the competence to handle its assets effectively. Of course, the inexperience of the FDIC does not distinguish Title II from the bankruptcy process, which calls for decisions by judges who know comparatively little about the firm or its industry. What does distinguish Title II is the concentration of decisionmaking authority in the hands of a single regulator. That authority is fragmented in the bankruptcy process. Although judges issue final orders, they are primarily refereeing a bargaining process that vests considerable power in the hands of the debtor in possession and its creditors. This concentration of authority in the hands of the FDIC may find some justification in the experience of Long-Term Capital Management. While LTCM was a well-known hedge fund, few anticipated in advance that, when its derivative contracts turned sour, many large financial institutions were potentially exposed to catastrophic loss. In the case of LTCM, private parties (after significant coaxing from the Federal Reserve) were able to execute a successful13 14

12 U.S.C. 1843(k). 12 U.S.C. 1843(k)(4)(A).

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workout. But it is easy to imagine a scenario in which this would not have been possible. Dodd-Frank gives the government the ability to step decisively into the breach in such a case. Such speedy decisionmaking could be substantially harder in a regime, like the Bankruptcy Code, in which decisionmaking authority is fragmented across multiple parties. We have highlighted the danger that a Title II liquidation could take a company by surprise, but Title II puts many safeguards in place. Before a Title II liquidation can begin there are both substantive and procedural hurdles. Section 203(b) provides that, before the liquidation can begin, the Secretary of the Treasury, in consultation with the President, must first find that a financial company is in default or is in danger of default. This inquiry is much like the Bankruptcy Codes provisions for the commencement of an involuntary case. It requires the Secretary to find that a case is likely to be commenced under the Bankruptcy Code, that the company has or is likely to incur losses that will deplete its assets and it will be unable to protect them, that its assets are less than its obligations to creditors, or that it is unable or likely to be unable to pay its obligations in the ordinary course of business.15 Because these rules are largely in harmony with the rules for an involuntary case, the company itself cannot be too surprised to find control wrested from it. Circumstances have to be so bad that, in the absence of Title II, the same company could have been pushed into bankruptcy. The difference is largely the decisionmakerthe Secretary, rather than unhappy creditors. Less clear-cut and more important is the requirement that, before the receivership begins, the Secretary find that alternative ways of resolving the financial distress would have serious adverse effects on the financial stability of the United States. The success of Chapter 11 in handling the collapse of very large corporations (such as Enron, General Motors, and Conseco) suggests that this threshold is a high one. Moreover, the Secretary has to find that no viable private sector alternative is available to prevent the default. In theory, this should further limit the scope of this provision as workouts of the sort that we saw in LTCM need to be off the table as well. Of course, the absence of such a receivership regime may be what brings private parties to the table in such cases. The presence of Title II may make them less inclined to do so. The Secretary must also engage in some balancing of the interests of creditors, counterparties, and shareholders, but the balancing required is somewhat toothless. The Secretary must find only that15

203(b)(4).

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the effect on their claims and interests is appropriate given the danger posed to the financial stability of the United States.16 Moreover, in making her decision, she must be on guard for how her failure to take action has the potential to increase excessive risk taking on the part of creditors, counterparties, and shareholders.17 In addition to the substantive criteria for taking action, there are also significant procedural hurdles. Before the Secretary of the Treasure can act, the receivership must be approved by both the Federal Reserve Board and the FDIC.18 Before the Secretary can act, two-thirds of the Board of Governors of the Federal Reserve and twothirds of the members of the FDICs Board of Directors must give their approval.19 This approval protocol has often been dubbed a three-key process because three approvals are required.20 By placing two of the keys in the hands of independent agencies, the trigger is insulated from the pressures of day-to-day political forces. Absent extraordinary circumstances, the entities that will find themselves in Title II are likely those financial companies already subject to oversight under Title I. This regulatory oversight, like any other, may be done badly, but it seems unlikely that those regulated will be caught unawares or that those who trigger the Title II liquidation will be wholly in the dark or that the FDIC will be caught flat-footed when it becomes the receiver.

B. Judicial Review The seizure of a financial company, like the seizure of anything else by the government, entitles those affected some access to judicial review. At first blush, it might seem that this legislation may fall short. The Act emphasizes repeatedly that [e]xcept as provided in this title, no court may take any action to restrain or affect the exercise of powers or functions of the receiver hereunder, and any remedy against the Corporation or receiver shall be limited to money damages determined in accordance with this title.21 The Act permits203(b)(4). 203(b)(5). 18 For some entities, other agencies replace the FDIC. The SEC replaces the FDIC for brokers and dealers, and the Director of the Federal Insurance Office for insurance companies. 19 203(a)(1)(A). 20 See, e.g., Jeffrey N. Gordon, Avoiding Eight-Alarm Fires in the Political Economy of Systemic Risk Management, working paper (2010), available at http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1553880. 21 210(e). Similarly, 210(a)(9)(D) states that [e]xcept as otherwise provided in this title, no court shall have jurisdiction over(i) any claim or action for payment from, or any action seeking a determination of rights16 17

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only challenges to the threshold decision to commence the receivership, not to the details of its administration. A court enters the picture during the receivership principally to review claims and ensure adequate protection of secured creditors subject to priming liens. After the Secretary decides to take action, she must first seek consent from the board of directors of the financial company. The question of whether the government is overreaching arises only if such consent is not forthcoming, and one suspects it almost always will be. Board members will likely see the folly of trying to fight off the Secretary, the Federal Reserve, and the FDIC simultaneously. Moreover, they will also look to the comfort provided by 207, which protects them from liability for consenting in good faith to the receivership. If she fails to obtain the consent of the board of directors of the financial company, the Secretary must petition the United States District Court for the District of Columbia for an order authorizing the appointment of the FDIC as receiver.22 This is the only process that the company enjoys, and the scope of the courts review is narrow. It is limited to assessing whether the determination of the Secretary that the covered financial company is in default or in danger of default and satisfies the definition of a financial company under section 201(a)(11) is arbitrary and capricious.23 The district court is required to act within twenty-four hours.24 If it fails to act, the petition is granted by operation of law. Once FDIC receivership commences, any pending proceedings in bankruptcy courts or before the SIPC must be dismissed.25 The FDIC may exercise its authority as receiver for up to five years (the receivership can be extended additional years if necessary to pursue litigation).26 The scope of FDIC authority varies with the type of institution. With respect to brokers and dealers, the Corporation must appoint SIPC as trustee. If any assets and liabilities are not transferred by the FDIC to a bridge financial company, they are administered by SIPC pursuant to the typical rules applied in broker-dealerwith respect to, the assets of any covered financial company for which the Corporation has been appointed receiver, including any assets which the Corporation may acquire from itself as such receiver; or (ii) any claim relating to any act or omission of such covered financial company or the Corporation as receiver. 22 202(a)(1)(A)(i). 23 202(a)(1)(A)(iii). 24 202(a)(1)(A)(v). 25 208. 26 202(d)(4)

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liquidations.27 With respect to insurance companies, resolution must be conducted by the appropriate state regulators pursuant to state law.28 With respect to other financial companies, the FDIC serves as receiver and trustee and applies the procedures outlined in the Act, particularly 210. Thus, with respect to brokers, dealers, and insurance companies, the same government actor administers the institutions insolvency, whether it is subject to FDIC receivership or not. For other financial institutions, the relevant government actor is different outside receivership (the bankruptcy courts) than inside (the FDIC, subject to limited judicial review). The district courts decision is appealable, but there is no stay of the decision pending appeal, the appeal must be brought within thirty days, the appellate court must consider the appeal on an expedited basis, and the court is again limited to arbitrary and capricious review.29 More to the point, the courts decision shall not be subject to any stay or injunction pending appeal.30 As a practical matter, virtually any appellate review is likely to be equitably moot by the time it is heard. While this highly accelerated judicial process is extraordinary, in all likelihood it is not constitutionally suspect. The most obvious constitutional questions here arise from the Takings and Due Process Clauses of the Fifth Amendment. The former forbids government seizure of private property for public use without just compensation. An FDIC receivership is undoubtedly a taking of private property for public use. The Corporation succeed[s] to all rights, titles, powers, and privileges of the covered company and its assets, and of any stockholder, member, officer, or director of such company.31 And the Act undoubtedly offers compensation to aggrieved parties: any person having a claim against the Corporation as receiver is guaranteed compensation equal to what the person would have received if the Corporation had not been appointed receiver and the company27 205(a), (b). Although the SIPC must apply to a district court for a protective decree, the court is required to issue the decree automatically, 205(a)(2)(A), and no court may take any action to restrain or affect the exercise of powers or functions of the Corporation as receiver for a covered broker or dealer. 205(c). To the extent that counterparties or creditors are aggrieved by the transfer of assets to a bridge financial company, they may bring suit for money damages in a district court. 205(e). 28 203(e)(1). If state regulators fail to act promptly (within 60 days after the Secretarys decision, or after district-court approval of that decision), the FDIC may step into the shoes of the regulators. 203(e)(3). 29 202(a)(1)(B), 202(a)(2). 30 202(a)(1)(B). 31 210(a)(1)(A)(i).

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instead were liquidated under state or federal law.32 In theory, this compensation formula guarantees something close to just compensation. To be sure, recoveries are likely to be small or nonexistent. If the companys failure would indeed imperil the overall economy, we need to imagine what creditors would be paid in a world in which the overall economy is cratering and the government is doing nothing to stop it. Recoveries in that world are likely to be minimal. In application, of course, the FDIC may not compute just compensation correctly, but even then claimants could bring suit against the FDIC under the Tucker Act. Although Dodd-Frank repeatedly states that no court may take any action to restrain or affect the exercise of powers or functions of the receiver, it acknowledges claimants ability to bring suit for money damages, presumably under the Tucker Act.33 That is enough to avoid complications under the Takings Clause.34 Due Process questions loom a bit larger. The process here is one in which the financial company is given advance notice and opportunity for a judicial hearing.35 Notice and an opportunity to be heard generally constitute due process.36 The difficulty here, however, is the nature of the hearing. The District Court is not permitted to review the decision of the Secretary on the merits. Instead, it is obliged to focus narrowly on two questions: (i) whether the financial company is in default or in danger of default, and (ii) whether it satisfies the definition of a financial company. Moreover, the District Court must apply an arbitrary and capricious standard of review. The arbitrary and capricious standard standing alone does not seem problematic. The Supreme Court has long held that such review of agency action meets muster as a constitutional matter.37 It is the standard typically used in administrative law and courts have found it appropriate in assessing the decision to appoint receivers under the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA).38210(d)(2). 210(e). 34 See, e.g., Blanchette v. Connecticut General Ins. Corp., 419 U.S. 102 (1974). 35 202(a)(1)(A)(iii). 36 Mullane v. Central Hanover Bank & Trust Co., 339 U.S. 306, 313 (1950). 37 See, e.g., Yakus v. United States, 321 U.S. 414 (1944). 38 See, e.g., Franklin Sav. Assn v. Director, Office of Thrift Supervision, 934 F.2d 1127 (10th Cir. 1991).32 33

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The potential problem is not the standard of review, but the limitation on what can be reviewed. The court has no power to review the other critical findings that the Secretary must make before triggering the receivership. These findings include that the companys default exposes the United States to serious adverse effects on financial stability and that no viable private sector alternative is available.39 These findings seem as jurisdictional as the determinations that are subject to judicial review (the institution is in or danger of default and is a financial company), yet even if these findings are arbitrary and capricious, the legislation deprives the court of the power to do anything about it. We admit to being uncertain, however, whether this poses serious constitutional problems.40 Another potential problem is the mandate that the proceedings be conducted within twenty-four hours and in secrecy. It seems implausible that a reviewing court could digest the complex factual and legal issues within twenty-four hours. The time constraint will likely deprive financial companies of a meaningful opportunity for a hearing prior to a taking of their property, which is generally the acid test of a due process violation. To be sure, the companys owners can seek appellate review, but the lack of a stay pending appeal means that the issues will likely be moot by the time the appeal is decided. Secrecy is a potential problem as well. The petition is to be filed under seal and the district court must act without any prior public disclosure. Moreover, no one else is permitted to disclose the pendency of the court proceeding either. A person who recklessly makes such a disclosure is subject to criminal sanctions, including up to five years in prison.41 A mandate that such proceedings be secret may be constitutionally suspect, not because of due process, but because of the First Amendment. The Supreme Court has held on multiple occasions that secret criminal trials are inconsistent with the First Amendment rights of the press.42 The Court has not yet found a203(b). We are uncertain because the doctrine in this area is complex. Existing caselaw suggests that Congress has wide authority to restrict judicial review in public right cases. See generally RICHARD H. FALLON, JR., ET AL., HART & WECHSLERS THE FEDERAL COURTS AND THE FEDERAL SYSTEM, Ch. 4 (6th ed. 2009). We thank Henry Monaghan for his help here. 41 202(a)(1)(C). 42 Press-Enterprise Co. v. Superior Court, 464 U.S. 501, 508 (1984) (The open trial thus plays as important a role in the administration of justice today as it did for centuries before our separation from England. The value of openness lies in the fact that people not actually attending trials can have confidence that standards of fairness are being observed; the sure knowledge that anyone is free to attend gives assurance that established39 40

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right of public access for civil trials, but some lower courts have.43 Moreover, the logic of granting access to criminal proceedings applies equally with respect to civil proceedings. Exceptions can be made, of course, but in theory the way in which they must be made creates a problem. While the legislation mandates secrecy, the Court has also held that case-specific findings are required to overcome the presumption of openness.44 The secrecy provisions are unlikely to be contested. On the merits, success is far from certain. There is a long history of nondisclosure in the context of bank regulation,45 and the adverse consequences of premature disclosure are easy to imagine. More to the point, the only ones in a position to complain about the secrecy are the directors of the financial company, as they are the only ones who know about it, and they are probably the last one who would want the petition for a receivership to be disclosed. In the abstract, it might seem that even if each of these limitations on due process and freedom of speech were permissible, the combination of all of them might be toxic. It might seem that the government should not be able to gain the right to seize assets worth many billions by providing only a hearing done in the dark of night with the most critical issues taken off the table. But it likely suffices. Those who are adversely affected do have the right to go to court at a later time to adjudicate their claims.46 Recoveries are likely to be minimal, but the talisman of a due process violation has long been the inability to have ones claim adjudicated. That never happens here. More to the point, it is hard to imagine the circumstances under which challenges to these procedures are likely to be entertained.procedures are being followed and that deviations will become known. Openness thus enhances both the basic fairness of the criminal trial and the appearance of fairness so essential to public confidence in the system.). See also Richmond Newspapers, Inc. v. Virginia, 448 U.S. 555 (1980). 43 Huminski v. Corsones, 386 F.3d 116 (2d Cir. 2004). 44 Press-Enterprise Co., 464 U.S. at 510 (The presumption of openness may be overcome only by an overriding interest based on findings that closure is essential to preserve higher values and is narrowly tailored to serve that interest. The interest is to be articulated along with findings specific enough that a reviewing court can determine whether the closure order was properly entered.). 45 See, e.g., 5 U.S.C. 552(b)(8) (exempting from FOIA information contained in or related to examination, operating, or condition reports prepared by, on behalf of, or for the use of an agency responsible for the regulation or supervision of financial institutions). 46 210(a)(4).

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Political forces work to dissuade the Secretary from acting. She has every incentive to convince herself that a company is not systemically important. Given these incentives, it is unlikely that a court would conclude that the Secretarys findings (of systemic risk and the absence of private alternatives) were arbitrary and capricious, even if it had the power to make such a finding. II. Elements of the Title II Receivership Title II gives the FDIC expansive discretion in winding-down an institution in receivership. The most striking difference between the Title II receivership and a traditional reorganization is the absence of a debtor in possession. Upon being appointed as receiver, the FDIC succeeds to all powers of the company and its owners, including the power to operate the company, continue the employ of existing employees, and hire third parties, such as attorneys, asset management companies, and brokerage services.47 The FDIC may also appoint itself receiver of any distressed subsidiary whose failure would threaten market stability in the United States.48 The basic dynamics of the case are the same ones we see in Chapter 11.

A. Liquidating and Reorganizing the Institutions Modern reorganizations of large corporations usually take the form of a sale. Title II contemplates a similar process. The FDIC has the option of a piecemeal asset sale.49 Its favored avenue will likely be a merger of the institution with another company.50 The FDIC can also separate the good and bad assets and place the good assets in a new entity at the very start. The specific mechanism is the establishment of a bridge financial company to which the FDIC will transfer some of the institutions assets and liabilities. The FDIC will operate the company until it can be merged with another institution or until its equity can be sold to private investors.51 Through the creation of bridge financial companies, the FDIC can (implicitly) administer a conservatorship of the failing financial institution. A bridge financial company is a temporary financial institution owned and indirectly managed by the FDIC.52 The FDIC is authorized butSee 210(a)(1)(A)-(D), 210(a)(1)(L). 210(a)(1)(E). 49 210(a)(1)(G)(i)(II). 50 210(A)(1)(G)(i)(I). 51 201(A)(1)(F). 52 210(h)(2).47 48

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not required to capitalize the bridge bank.53 Alternatively, the bank can raise funds either by issuing equity or debt in private markets. Although it has a Federal charter, articles of association and bylaws that the FDIC drafts, a board of directors that the FDIC selects, and exemption from state or federal taxation, the bridge is not considered an agency, establishment, or instrumentality of the United States.54 The Corporation has virtually absolute discretion in selecting assets and liabilities to transfer to the bridge.55 The bridge will manage this portfolio with a view to merging with another financial company, selling a majority of its capital stock to private investors, or assumption of substantially all of the bridges assets or liabilities by another institution.56 The bridge financial company can be dissolved at any time by the FDIC.57 Merger with another company automatically terminates the companys status as a bridge financial company. So does sale of at least eighty percent of its capital stock.58 The FDIC may also choose to terminate the companys status as a bridge if it sells at least fifty percent of its stock to private investors or if another institution assumes substantially all of the bridge companys liabilities or purchases substantially all of its assets.59

B. Running the Process and Administering Claims The landmarks of the Bankruptcy Codeautomatic stay, claim allowance, avoidance actionsare evident in Title II. But Title II is littered with sometimes surprising deviations from the bankruptcy lawyers norm. Generally, but not always, these deviations are vindicating core policies of the reform legislation: facilitating rapid decisionmaking by the FDIC, avoiding the perception of a bailout by forcing the companys stakeholders to bear losses, punishing risktaking executives, and minimizing the burden on taxpayers.60 Automatic stay, claims allowance, and executory contracts. The need for FDIC speed likely explains deviations from the Codes rules governing the automatic stay and claims allowance. Any collective process of a distressed firm must put a stop to the individual efforts of investors to grab assets. The Bankruptcy Code does this through210(h)(2)(G). 210(h)(2)(A)-(D), (8)(A), (10). 55 210(h)(1)(B). 56 210(h). 57 210(h)(15). 58 210(h)(13)(A), (C). 59 210(h)(13)(B), (D). 60 204(a), 206.53 54

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its automatic stay, which stops all formal and informal collection efforts everywhere. Title II does something similar by cutting off all rights of shareholders and creditors, except for their right to payment, resolution or other satisfaction of their claims,61 and by forbidding courts from issuing attachment or execution upon assets in the FDICs possession.62 But the commencement of a Title II receivership does not automatically stay judicial proceedings. The FDIC must instead petition to stay these proceedings. Although courts must grant the petition, the stay cannot exceed ninety days.63 Similar deadlines force the FDIC to act quickly in allowing and disallowing claims. Under Title II, claims are defined as expansively as they are under the Bankruptcy Code,64 but the allowance/disallowance decision must be rendered within 180 days after commencement of the receivership (extensions are possible, however).65 If speedier decisionmaking is necessary to avoid irreparable injury to a claimant, the FDIC must render a decision within ninety days.66 The Corporation may disallow all or part of any timely-filed claim that is not proved to the satisfaction of the Corporation. If, however, a claim is disallowed, the claimant may seek judicial determination of its claim in a federal district court.67 The FDIC is free to affirm or repudiate any ongoing contract, free of judicial review, within a reasonable period of time.68 Counterparties to repudiated contracts are entitled to damages claims, but claims for punitive damages, lost profits, or pain and suffering are disallowed.69 An unusual feature here, from a bankruptcy perspective, is the Corporations authority to assume executory loan agreements. Section 210(a)(12)(D) authorizes the FDIC to enforce any contract to extend credit to the covered financial company or bridge financial company. This too likely reflects the policy in favor210(a)(1)(M). 201(a)(9)(C). 63 210(a)(8). 64 201(a)(4). In this respect Title II differs from the FDIA. Those whose rights against a bank are contingent have found that their rights may be slighted under receiverships under that Act. The FDIC grounds this position in 12 U.S.C. 1821(e)(3). See, e.g., FDIC Statement of Policy regarding Treatment of Collateralized Letters of Credit after Appointment of the FDIC as Conservator or Receiver, 60 Fed. Reg. 27976, May 26, 1995, effective May 19, 1995. 65 210(a)(3)(A)(i). 66 210(a)(5)(B). 67 210(a)(4). 68 210(c)(1),(2). 69 210(c)(3)(A),(B).61 62

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of a speedy receivership process: whenever possible, the FDIC can draw on existing lines of credit. Avoidance actions. Some differences between the Bankruptcy Code and Title II may be unintentional. For example, Section 210(a)(11) sets out avoidance powers that are virtually identical to the fraudulent conveyance and preferential transfer provisions of 547 and 548 of the Bankruptcy Code. One important difference is the standard for intentional fraudulent transfers to non-insiders. The Bankruptcy Code permits the trustee to attack intentional fraudulent transfers regardless of the debtors financial condition at the time of the transfer.70 By contrast, Title II subjects them to attack only if they rendered the firm insolvent or occurred while the firm was insolvent.71 In light of the Reform Act drafters obvious intention to track the Bankruptcy Code, this may be an unintentional drafting error. Someone who engages in a sham transaction that has many badges of fraud should not get off the hook merely because her machinations took place while the firm was still above water. Another puzzling difference is the absence of a provision analogous to 544 of the Bankruptcy Code, which (among other things) gives the trustee power to attack unperfected security interests. That power may be implicit in 210(a)(1)(D), which states that the FDIC shall, as receiver for a covered financial company, and subject to all legally enforceable and perfected security interests and all legally enforceable security entitlements in respect of assets held by the covered financial company, liquidate, and wind-up the affairs of a covered financial company . Finally, the rights of secured creditors are only implicitly protected through 210(a)(1)(D) and other provisions that acknowledge perfected security interests. Section 210 provides the bulk of the substantive rules of Title II and it expressly provides that it does not affect secured claims . . . except to the extent the security is insufficient to satisfy the claim, and then only with regard to the difference between the claim and the amount realized from the security.72 Creditor priorities. A desire to protect taxpayers likely explains the priorities among unsecured claims set out in 210(b)(1). These deviate substantially from the Code,73 particularly with respect to the claims of the federal government. First priority goes to adminis11 U.S.C. 548(a)(1)(A). 210(a)(i), (ii). 72 210(b)(5). 73 But the priority provisions of the Bankruptcy Code are hard to derive from first principle, and hence it is hard to argue that these make less sense.70 71

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trative expenses, followed by any amounts owed to the United States, then wages, salaries, and commissions owed to ordinary employees, and finally contributions owed to employee benefit plans. These are subject to the same $11,725 in 507 of the Bankruptcy Code and are also indexed by inflation. After these priority claims come all other general unsecured claims and then subordinated unsecured claims, followed by wages, salaries, and commissions owed to senior executives and directors. Anything left goes to equity holders. But the FDIC can deviate from this scheme to promote market stability. The Corporation has broad authority to favor some creditors over others with equal priority, provided that the favored treatment maximizes asset value, minimizes losses, or is otherwise essential to the receivership.74 The Corporation may also pay some creditors immediately, but defer payments on others.75 But even these outcomes are not unfamiliar to bankruptcy lawyers. In Chapter 11 reorganizations, creditors as a class can agree to take less than others if it is the sensible course. Moreover, the debtor enjoys a limited ability to make payments to critical vendors and others if it advances the interests of the estate as a whole. Title II permits much the same, though it is vindicating a different policy (market stability). Postpetition financing. The desire to avoid anything resembling a bailout figured large in the political dynamics of the Act. This manifests itself in several places. One place is in the rules governing postpetition financing. In recent years, the DIP financer has emerged as one of the major players in the reorganization process. Title II contemplates that this role too is one that the FDIC will assume, although private loans are also possible. The FDIC has authority to extend loans to the covered financial company, purchase the institutions debt obligations, purchase or guarantee its assets, assume or guarantee its obligations, and take a lien on its assets.76 The FDIC may not, however, take an equity interest in the institution, reflecting Congresss aversion to AIG-style bailouts.77 Anti-bailout philosophy is more apparent in other limits on the FDIC. The Corporation must finance its activities as receiver through an orderly liquidation fund, which is funded by borrowings from the Treasury.78 The FDICs authority to borrow from the Treasury, however, is tightly constrained. The Corporation cannot issue debt in connection with a receivership that exceeds specified thresh210(b)(4). 210(a)(7)(A). 76 204(d). 77 206(6). 78 210(n)74 75

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olds. During the first thirty days of the receivership, loans cannot exceed ten percent of the total consolidated assets of the covered financial company. After the first thirty days, it cannot exceed ninety percent of the fair market value of the companys total consolidated assets available for repayment.79 To repay its obligations to the Treasury, the FDIC is permitted to impose assessments on a broad range of financial institutions.80 Institutions subject to assessment include those that received more than their pro-rata share of proceeds from a receivership commenced by the FDIC, any bank holding company with at least $50 billion in total consolidated assets, any nonbank financial company subject to the Feds systemic risk oversight authority, and any other financial company with total consolidated assets of at least $50 billion.81 In this way, Title II ensures that losses from receiverships are borne primarily by the institutions stakeholders and secondarily by members of the industry. But the FDIC need not be the sole source of financing. If the Corporation creates a bridge financial company, the company may obtain financing from private lenders. The rules governing this financing are virtually identical to the rules governing DIP financing under the Code. For example, if the bridge is unable to obtain unsecured credit, the FDIC may authorize it to issue debt with priority over all other obligations (super-administrative expense priority), with a lien on unencumbered assets, or with a junior lien on encumbered assets.82 The FDIC may also authorize the bridge to issue debt with first-priority security interests in property that is already encumbered by liens.83 Such a priming lien, however, requires adequate protection and a hearing before a district court.84 Title II cannot be faulted for providing too much process, but here, as elsewhere, it seems to provide such process when it is due.85 Executives. Title II includes multiple provisions designed to punish senior executives and directors who contributed to the insti210(n)(6) 210(o)(1)(B). 81 210(o)(1)(A), (D). 82 210(h)(16)(B). 83 210(h)(16)(C)(i). 84 210(h)(16)(C)(ii). 85 Failing to provide secured creditors with adequate protection and adequate protection invites the sort of challenges that spelled trouble for Frazier-Lemke. See Louisville Joint Stock Land Bank v. Radford, 295 U.S. 555 (1935); Wright v. Union Central Life Insurance Co., 304 U.S. 502 (1938).79 80

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tutions failure. They are similar in spirit to a number of provisions added to the Bankruptcy Code in 2005. The FDIC may sue directors, officers, attorneys, accountants, and other actors for grossly negligent conduct that resulted in the improvident or otherwise improper use or investment of any assets of the covered financial company.86 The FDIC may also claw back compensation paid during the two years preceding the receivership from any current or former executive who is substantially responsible for the failed condition of the covered financial company.87 Here, compensation is defined broadly to include salary, bonuses, benefits, golden parachute benefits, and any profits realized from the sale of the securities of the covered financial company.88 Additionally, the Federal Reserve (or other appropriate agency) can bar senior executives and directors from working for any financial institution for a period not to exceed two years. Grounds for this sanction include evidence that the executives or directors, directly or indirectly, engaged or participated in any unsafe or unsound practice in connection with any financial company, received financial gain or other benefit by reason of this practice, and the practice demonstrates willful or continuing disregard for the safety or soundness of such company.89

C. Safe harbors for qualified financial contracts Financial contracts are typically the core assets of nonbank financial institutions. Before Title II, a distressed institution faced great challenges in managing these assets due to the Bankruptcy Codes safe harbors. These safe harbors permit certain counterparties to qualified financial contracts (QFCs)repurchase agreements, commodity and forward contracts, security contracts, and swapsto treat a bankruptcy filing as an event of default. They may terminate all contracts with the distressed institution, net out and set-off multiple contracts, compute a net obligation, and seize available collateral to the extent that the net obligation is owed by the institution. The automatic stay does not apply to these counterparties; nor do the rules governing ipso facto clauses, preferential transfers, or (constructive) fraudulent conveyances. In short, the safe harbors ensure that a counterpartys rights under a qualified financial contract (QFC) are unaffected by the bankruptcy process. These rules expose failing financial institutions210(f), (g). 210(s). 88 210(s)(3). 89 213.86 87

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to a rushed, free-for-all liquidation by counterparties. This exposure is said to have prompted the Federal Reserves efforts to orchestrate a bailout of Long-Term Capital Management in 1998. The Federal Reserve feared that a free-for-all liquidation of LTCM would have destabilized markets. The safe harbors may also have contributed to the market instability during the days immediately before and after Lehman Brothers bankruptcy filing. The Reform Act adopts a different approach to QFCs. The new approach, modeled on the FDIA, continues to offer safe harbors for these contracts. Counterparties to securities contracts, commodity and forward contracts, repurchase agreements, and swaps are still immune to preferential and (constructive) fraudulent transfer avoidance actions.90 This safe harbor is potentially broader than the one available under the Bankruptcy Code because it applies to all QFC counterparties, not just the particular counterparties singled out for protection by the Code. For example, while all swap counterparties benefit from the Codes safe harbors91 only designated counterparties to securities, commodity, and forward contracts, such as commodity brokers, may benefit from the Codes safe harbors for those QFCs.92 Additionally, Title II continues to protect the contractual rights of counterparties and to make clear that commencement of the receivership process generally does not alter those rights. For example, it provides that no person shall be stayed or prohibited from exercising any right that such person has to cause the termination, liquidation, or acceleration of any qualified financial contract with a covered financial company which arises upon the date of appointment of the Corporation as receiver for such covered financial company or at any time after such appointment.93 But the Reform Act does temporarily nullify some important contractual rights. First, the Act temporarily nullifies ipso facto (walkaway) clauses that suspend[ ], condition[ ], or extinguish[ ] a payment obligation of a counterparty solely because of either the financial institutions insolvency or the appointment of the FDIC as receiver.94 Additionally, and with one exception, the Act temporarily suspends the payment obligations of the covered financial institution.95 The exception involves QFCs traded through clearing organi210(c)(8)(C)(i). See, e.g., 11 U.S.C. 101(53C), 546(g). 92 See, e.g., 546(e). 93 210(c)(8)(A)(i). 94 210(c)(8)(F)(i), (iii). 95 210(c)(8)(F)(ii). This suspension of payment obligations does not apply to exchange-traded QFCs.90 91

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zations: If the FDIC fails to satisfy any margin, collateral, or settlement obligations under the rules of the clearing organization, the clearing organization shall have the immediate right to exercise, and shall not be stayed from exercising, all of its rights and remedies under its rules and applicable law.96 By nullifying walkaway clauses and temporarily suspending payment obligations, the Act gives the FDIC time to repudiate QFCs or transfer them to other institutions. The time, however, is quite limited. Both walkaway rights and contractual payment obligations become enforceable again after (i) the contract has been transferred to another entity, such as a bridge financial company, or (ii) 5:00 pm EST on the business day following the date on which the FDIC was appointed as receiver.97 However, a counterparty cannot enforce a walkaway right merely because QFCs have been transferred to a bridge company, which shall not be considered to be a financial institution for which a conservator, receiver, trustee in bankruptcy or other legal custodian has been appointed, or which is otherwise the subject of a bankruptcy or insolvency proceeding. But the FDIC does not possess the same assume-or-reject authority that the Bankruptcy Code gives to trustees and debtors in possession. The Code allows the DIP to cherry pick contracts with the same counterparty. Instead of netting multiple contracts to compute an overall obligation owed to or by the DIP, the Code allows DIPs to act strategically by assuming contracts that are in-themoney (assuring full payment by the counterparty) and rejecting those that are out-of-the-money (assuring that counterparties are treated as ordinary unsecured creditors, who typically receive less than full payment). The Reform Act implicitly forbids this cherrypicking by requiring the FDIC to repudiate all or none of the QFCs with a given counterparty.98 The same all-or-none principle applies to decisions by the FDIC to transfer QFCs to a bridge financial company. The Corporation may transfer all or none of the contracts with a particular counterparty. Moreover, the transfer must include not just the contracts, but also any associated claims of or against the counterparty and any property or credit enhancements securing obligations under the contract.99 In sum, Title II ensures that the insolvency of the financial210(c)(8)(G). 210(c)(8)(F)(ii), (10)(B)(i) 98 210(c)(11). 99 210(c)(9)(A). financial contracts could be firm-specific assets. Think of a specialized, OTC hedge: It is a special contract between two parties; it is not a traded instrument.96 97

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company leaves performance of QFCs unaffected. Appointment of a receiver does not trigger any changes in the contract. After being transferred to a bridge, the contract is performed according to its original terms, as if nothing had happened. Seen at a distance, these provisions chart a sensible middle course between subjecting financial contracts to something akin to the automatic stay and exempting them entirely. All executory contracts give the debtor in possession an opportunity to take advantage of the third party. If you promise to sell the debtor a particular component at $100 at the end of the year and the debtor files for bankruptcy when the market price of that component is at $100, the debtor has an incentive to delay the decision to accept or reject the executory contract. If the price falls, the contract can be rejected; you as seller will receive a claim for damages, but it will be paid pennies on the dollar. If the price of the component rises, the debtor (and all her creditors) will capture the benefit of paying only $100 for a component that is worth more. In the case of an ordinary contract, however, the volatility of the price of the component is typically only one part of the picture, and often it is a small part. The debtor delays the breach-or-perform decision, not because it is exploiting price volatility, but rather because it takes time to decide whether the debtor will even continue making the product for which the component is used, and because it takes time to determine whether a higher quality or more suitable substitute can be obtained elsewhere. Here, the costs that the automatic stay imposes on the seller are small and the benefit to the debtor large. In the case of a financial contract, by contrast, volatility matters much more. Indeed, for the vast majority of debtors it is the only feature that matters. A financial contract is, almost by definition, a contract in which the counterparties are trading volatility. The counterparties are bearing opposite sides of the risk that market movements will change the price of some underlying asset, index, or other measure of value. If an automatic stay were applied to these contracts, it would fundamentally alter the terms of trade by giving the debtor the ability to gain from favorable price movements and limit its liability for unfavorable ones (cherry-picking). Put differently, an automatic stay would give the debtor the option value associated with the volatility in the underlying price. Moreover, cancelling financial contracts typically presents few problems for firms that are not systemically important. For the most part, the financial contract

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brings no firm-specific synergy.100 More to the point, as long as the market is liquid, as it should be outside of the times of crisis for which Title II is intended, the debtor can simply recreate the same contract and continue to enjoy whatever benefits the old financial contract provided. To be sure, it may be very costly to recreate the contract. The same market conditions that have rendered the debtor insolvent have also probably raised the price it faces to enter new financial contracts. But the same market discipline faces any troubled business, which will face different terms of trade when it is healthy than when it is distressed. This is the line of argument often used to distinguish ordinary contracts from financial contracts and for subjecting only the former to the automatic stay.101 A problem arises, however, in the case of systemically important companies whose assets consist of large bundles of financial contracts.102 Without the protection of an automatic stay, these companies are torn apart when they become insolvent. Recall Lehman Brothers: It was party to about 1.5 million transactions with over 8,000 counterparties when it filed for Chapter 11. Less than two weeks later, eighty percent of those transactions had been liquidated.103 When an institution like Lehman is torn apart, markets can destabilize. As the institution defaults on millions of contracts with thousands of creditors, counterparties and creditors may too suffer distress and fail (as the Primary Reserve Fund did after Lehmans collapse). And as thousands of counterparties rush to sell collateral and rehedge positions that were exposed by the institutions default, market prices will experience wild swings in value. These gyrations, of course, may severely undermine investor confidence, as we saw in flight to quality after the Lehman Brothers bankruptcy and AIG bailout.100 There are, of course, some exceptions. For example, there can be customized contracts between two parties, such as a specialized OTC hedge that is of particular value to the debtor and that cannot be readily replicated. 101 Another line of argument distinguishes ordinary contracts from QFCs on grounds that the latter contracts are systemically important. Exempting QFCs from the automatic stay, it is argued, promotes systemic stability. This argument is controversial and hard to square with the DoddFrank legislation, which deviates from the bankruptcy codes safe harbors for QFCs in order to promote systemic stability. See Franklin R. Edwards and Edward R. Morrison, Derivatives and the Bankruptcy Code: Why the Special Treatment?, 22 Yale J. Reg. 91 (2005). 102 See generally Morrison, supra note 1. 103 Harvey Miller, Discussion at Sixth Annual Deals Roundtable, Columbia Law School (Nov. 24, 2008).

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In this setting, the ordinary bankruptcy rule for QFCs exempting them from the automatic stayis no longer attractive. While we do not want to permit cherry-picking, value exists in the various bundles of contracts that may be impossible to recreate in times of severe economic distress. Title II creates a regime that allows for an intermediate treatment of financial contracts that places them between ordinary executory contracts and financial contracts in the typical Chapter 11. In this sense, it does not turn its back on Chapter 11 as much as it creates a compromise between two positions that are already embedded in existing bankruptcy law. III. The Effectiveness of Title II The goal of Title II is to provide a stabilizing force when systemic institutions crater, but several features undermine that goal. First, the resolution process will generate significant uncertainty surrounding the value of financial contracts and creditors claims. Creditors are entitled to a minimum recovery equal to what they would have received if both (i) the institution had been liquidated under Chapter 7 and (ii) the FDIC had not been appointed as receiver.104 But the FDIC is appointed as receiver only if the institutions failure would have serious adverse effects on financial stability in the United States.105 Thus, to determine the minimum recovery to creditors, we must imagine the liquidation value of the institution in an economy that is suffering an economic collapse. That liquidation value is likely to be close to zero. The minimum recovery is particularly uncertain for creditors with rights of setoff. The legislation permits the FDIC to sell assets, free and clear of rights of setoff.106 Affected creditors receive minimal compensation in the form of priority above general unsecured claims, but below administrative claims and certain other high-priority unsecured claims (e.g., wage claims of ordinary employees). Creditors can, of course, receive more than this minimum recovery if the FDIC determines that a higher recovery is necessary to maximize the value of the institutions assets or facilitate continued operations.107 But these higher recoveries may eventually be clawed back by the FDIC. Again, the legislation mandates that the Title II receivership be self-funding or at least not publicly funded. Section 210(o) directs the FDIC to imposes assessments on claimants to the210(d)(2),(3) 203(b)(2). 106 210(a)(12)(F). 107 See 210(b)(4), (d)(4), (h)(5)(E).104 105

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extent that they received amounts greater than the value the claimant was entitled to receive from the Corporation on such claim solely from the proceeds of the liquidation of the covered financial company under this title.108 It is unclear whether proceeds of the liquidation of the covered financial company under this title is equivalent to the minimum payment guaranteed to unsecured creditors described above. Together, these provisions may create significant uncertainty surrounding the value of claims against a failing financial institution. That particular creditors receive nothing in the event of a Title II receivership is not necessarily a problem per se, but the ambition of the law and the justification for government intervention in the first instance is to provide stability when the failure of the company threatens the United States economy as a whole. If payments are uncertain and if it is not clear that payments can be kept even after they are made, one can question how much stability the law in fact provides. Limitations on the ability of the FDIC to extend credit may also undermine the ability of the Title II receivership to provide stability. Again, the liquidation fund is capitalized by borrowings from the Treasury and there is a strict cap on total borrowing per receivership.109 Regardless of whether the fear of bailouts justifies such limits, they necessarily limit the ability of the Treasury, Federal Reserve, and FDIC when they want to use it, which again is only supposed to happen when there are systemic risks to the economy as a whole. Though these agencies can petition Congress for additional funding in the event of an emergency, one can doubt that either political will or even time will be available. Finally, the legislation does little, if anything, to promote international cooperation in the event of a financial meltdown. Section 202(f) calls for a study regarding international coordination. In the meantime, Section 210(a)(1)(N) exhorts the FDIC to cooperate, to the maximum extent possible, with the appropriate foreign financial authorities regarding the orderly liquidation of any covered financial company that has assets or operations in a country other than the United States. Without treaties or other multilateral agreements, this exhortation offers little comfort. In sum, the common complaint against Title IIthat it puts government regulators to solve a problem that existing bankruptcy law or a new chapter of the Bankruptcy Code might solvemisses the point. To a very large extent, Title II is consistent with the basic108 109

210(o)(1)(D)(i). See 210(n)(6).

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principles of bankruptcy law. The terminology is different, but this is not a matter of substance. Its basic features and ambitions are the same. The striking differencesthe eligibility rules, the minimal judicial involvement, and the consolidation of many different roles in a single government regulatorderive from its underlying premise. A Title II receivership can begin only when private solutions and ordinary judicial processes fail. One can doubt the competence of government regulators to handle the problems of a financial company that suddenly poses a systemic risk to the economy. The FDICs success in the past may derive in large measure from its having regulated the failed bank closely in the past and being already intimately familiar with its operation. Neither the FDIC nor any other government regulator will be in a similar position if a toxic hedge fund, a Long-Term Capital Management on steroids, appears in the next meltdown. But to say that the FDIC will be badly equipped is not to say that anyone else will be better equipped. Title II, like the Bankruptcy Code, provides a safety net. The argument against it may be not so much that it is a poor safety net, but rather that people tend to be much more careful when there is no safety net in place at all, poor or not. The absence of a safety net concentrates the mind wonderfully. Cooler heads may have prevailed in the case of LTCM precisely because there was no one for the investment banks to fall back on. There was nothing analogous to Title II to come to the rescue of LTCM if they did not. But this line of reasoning assumes that the relevant actors will act rationally when left to fend for themselves. This path contains risk as well. In a world where too many people on Wall Street are still twenty-eight-year-old MBAs who know everything, it may not be a risk worth taking.